True or false: the term “hard money loan” was coined because this type of loan is hard to get. The answer is: false. If a borrower has a good deal, the right documents in order, a well-prepared exit strategy, and enough cash to close, a hard money loan is relatively simple to obtain. In fact, the approval process for a hard money loan is much more flexible, and the lender can close much faster than a conventional bank loan.
Though many investors have realized the benefits of hard money loans, this misconception—as well as many other age-old myths about hard money loans and lenders—are holding many potential real estate investors back from success. If you want to scale your real estate investing business, you need to leave the misconceptions behind.
Below we uncover the truth behind six common hard money loan myths:
#1 No Docs Needed
Fact: Though hard money lenders are more lenient than conventional lenders when it comes to documentation, the basics are still essential for a borrower’s loan qualification. Hard money lenders require documentation to evaluate the risk associated with the project and set loan terms accordingly, as well as to protect both themselves and the borrower from potential legal challenges.
One of the most important pieces of paperwork is the appraisal—the third party’s assessment of a property’s value and future potential. Other documents often include a title report, title insurance, a rehab budget for the property, and government-issued identification for the guarantors. The more well-prepared a borrower is, the faster the loan process becomes.
#2 Desperate Borrowers
Fact: This is a misconception regarding hard money lenders’ flexibility. For the most part, hard money lenders will overlook certain shortcomings in a potential borrowers financial history or experience—for example: credit score.
However, many borrower’s often come to hard money lenders—like ABL—with a credit score that is considered bankable. Essentially, most potential borrowers are choosing a hard money loan over a conventional loan, not using it as a last resort. Borrowers decide to apply for a hard money loan for these two key benefits: the types of loans being offered (like rehab or construction), as well as the lenders’ closing speed and flexibility.
If a borrower does not want to pay the hard money interest rates for the benefit of doing more deals, they have a few options. First, they can pay a bank loan interest rate but have to deal with the lengthy closing time and stricter underwriting. They can also use their own cash, but will likely have to limit the number and size of their deals due to financial constraints. Or, a borrower may decide to use a partner and engage in a profit share – but this is almost always more expensive than the interest rate of a hard money loan. This is why a hard money lender is not usually a borrower’s last choice.
Smart investors tend to see leveraging hard money as one of the necessary tools to grow their investing business quickly and consistently.
#3 Too Risky
Fact: Since hard money lenders are often lending their own money to borrowers, they are less likely to approve truly risky deals that will leave themselves and the borrower with less than what they started with.
Plus, a good local hard money lender is situated where they lend. This means that they have advanced insight into their local markets, so they will know when a deal is too risky or just “risky enough.” For the most part, if you and your deal look promising on paper, a bank or conventional lender will quickly approve your loan—even if in reality the project is not set up for success. Hard money lenders take the time to evaluate your project and the property as best as they can to ensure your success.
#4 More Expensive
Fact: Technically, hard money loans are more expensive than conventional loans because of their higher interest rates and other closing costs. But for most real estate investors, hard money loans are simply seen as the cost of doing business—paying for the cash (or tools) they need to buy and rehab their properties.
However, hard money loans may save you money in other ways. Remember: time is money. Hard money loans often have shorter terms, quick approvals, no prepayment penalties, and are flexible with borrowers’ timelines. Shorter loan terms also mean that you can pay off the loan faster and pay less lifetime interest.
Plus, many banks will only provide 50-65% of the total project costs, while hard money lenders usually offer 80-90%. So, you may end up paying more in total expenses, but you will be investing less of your own money into the project as a whole.
#5 Loan Sharks
Fact: False. This is somewhat of an outdated depiction of hard money lenders. Nowadays, there are billion dollar hard money lending companies that lend all over the country and are as legitimate as banks.
Most hard money lending companies—even small ones—are well-established and reputable. However, like any industry, there are the less reputable players so always be sure to do your homework before bringing on a new lending partner.
#6 No Exit Strategy
Fact: This misconception most likely stems from the far and few “loan to own” hard money lenders—ones all borrowers should avoid. These types of lenders seem to want your investment to fall through so they can take the property back at a discount.
However, a reputable hard money lender wants to hear a borrower’s exit strategy. This is because they do not want to end up owning a property and possibly having to go through the foreclosure process. Plus, they are putting a lot of their own time and money in to your project.
Having a strong exit strategy is part of proving your reliability to a lender. The most common exit strategies include: selling the rehabbed property, or refinancing into a longer term mortgage and holding the property for rental income. Your exit strategy must match your property as well as your own abilities and history. For example, if you happen to have a credit score in the lower 500s, refinancing your property is not the avenue for you—you will most likely not qualify for a bank loan. So figure out what fits best with your situation.
The Truth About Hard Money Loans
In recent years, hard money lenders have become a much more mainstream source of financing in the real estate world. Experienced and inexperienced investors alike are understanding the beneficial differences—whether it is speedy closings, flexibility, or inside knowledge—between hard money and conventional lenders that make hard money loans a better choice for their projects. Fortunately, myths that have always surrounded hard money loans are slowly being dismantled as more hard money lenders make a name for themselves and more investors turn to hard money lenders for the capital their business needs to succeed.