Hard money loans are financing solutions provided by private lenders (instead of traditional banks) and backed by assets (usually the commercial real estate property in question) instead of the borrower’s credit. They are excellent options for commercial property investors looking to build or flip a property.
Security, flexibility, and speed are three things that make hard money loans appealing. The private investors who lend the money have more control over approvals and loan terms. This is why hard money loans, in general, tend to be more flexible, more available, and faster.
You’ve probably heard of the many benefits of hard money loans for commercial real estate investors, but perhaps you’ve never used one before. Where do you start?
Hard money loans don’t work like traditional mortgages, so the process is quite different. Here are some tips on how to get a hard money loan easily and quickly:
#1 Make sure you have enough money for a down payment, plus fees.
Down payments on hard money loans are usually larger than down payments required on traditional mortgages because the loan is backed only by the commercial property in question. To figure out how much money you need to put down, get the difference between the purchase price plus your budget and about 70% of the after repair value.
Example: Let’s assume that you are purchasing a property for $2M and have a $500K budget, and you expect an ARV of $3M. You need a down payment of $400K.
Besides the down payment, you may also need to pay for closing costs, property insurance, underwriting fees, and other expenses. It’s important to have the capital to afford these costs as well.
#2 Structure your business correctly.
Investing in commercial properties is a tricky business. Even the best-planned projects don’t always succeed, and unforeseen difficulties can quickly become complicated. This is why commercial property investors are advised to set up S-corps or LLCs for their real estate investing activities. It would be best if you did the same to limit your risks and protect your personal assets.
Besides, most hard money lenders only work with LLCs and corporations. That’s because these lenders do not and cannot issue consumer loans. They can really only work with LLCs to be able to categorize the transaction as a business transaction.
Don’t worry; setting up a corporation or limited liability company is pretty simple and costs only a few $100 in most states.
#3 Make a shortlist of reputable—preferably local—hard money lenders.
Hard money lenders are not standardized like banks nor heavily regulated like traditional financial institutions. These are private businesses or individuals, so you have to be extra careful in choosing a trustworthy want to work with.
Here are some of the most important factors to think about when comparing hard money lenders:
- Reputation: Has the lender worked with other commercial real estate investors, flippers, and builders in the area before? What do their previous clients say about them?
- Expertise in your locality: Does the lender understand your area?
- Speed: How quickly can they provide you the funds you require for your project? Ask about how long approvals usually take and how many days it will take you to get the money.
- Affordability: Compare rates and fees among a handful of lenders. Hard money loans carry higher interest rates compared to traditional bank loans, of course, but you can still get reasonable rates if you look hard enough.
It’s also a good idea to ask the following questions when evaluating lenders:
- Are you the actual lender or a broker?
- Is an appraisal required?
- What documents do I need to submit to apply for a hard money loan?
- What is your interest collection schedule?
- Should I need an extension? What happens?
- Can you provide me a list of references I can talk to?
The hard money lender’s website will probably have all this information, but it’s a good idea to call them or visit them and their office if possible. Most hard money lenders will offer similar requirements, terms, and rates (especially those that do business in the same state or city). By talking to them in person, you can get a better sense of their quality of customer service and how comfortable you are working with them.
#4 Prepare your proof of income.
Even though it requires less paperwork to get approved for a hard money loan than securing a bank loan, you still need to show proof of income. The lender will want to see that you can afford to make the payments.
#5 Have an exit strategy.
A hard money loan is a short-term deal usually lasting 12 to 24 months. Lenders will want to know your repayment or exit strategy right from the start. One of the most common exit strategies is to sell the commercial property in question within the loan period. After all, most hard money funds are used for fix-and-flip projects and construction, so investors sell the asset for a profit when the work is complete.
You need to have a plan for how to secure a more traditional loan later on if you don’t plan on selling the property quickly or can’t sell it fast enough for some reason or another.
#6 Send your applications.
It’s so much easier to apply for hard money loans than to apply for mortgages and other bank loans. There is almost no prequalifying involved, and applications can usually be lodged online.
#7 Review all documents with a lawyer.
Hard money lenders are private individual investors and organizations that draft their own contracts. Protect yourself by discussing all documents with a lawyer once you’re approved. Pay special attention to the fees (look for any hidden charges), the repayment schedule, and penalties.
Securing hard money funding for your next construction or fix-and-flip project is very different from securing a traditional mortgage. That said, it is much easier in most cases. The integrity of the property is more important than your personal finances. Requirements are also straightforward, and pre-qualifications are not stringent. If you’re interested in hard money loans for commercial real estate, contact us. We’d be happy to hear all about your project and see if we can help.