Whether you’re dipping your toes into the real estate investment market or you’re a seasoned investor, you may be exploring the benefits of working with a hard money lender. Whereas traditional banks supply financing by using rigid thresholds to evaluate the borrower’s present financial state, hard money lenders have more flexibility.
Because hard money lenders are backed by private investors and their own cash, there is more leeway when it comes to lending criteria. Hard money lenders evaluate borrowers on the basis of cash on hand, credit, the future value of the property after it’s fixed up or built (aka the repair value or ARV), and most importantly: real estate experience.
This doesn’t mean that it’s “easier” to get a hard money loan — just different. But it does mean that when you choose a hard money lender, you’re choosing more than a financial backer. You’re choosing a business partner. And to avoid a bad deal, you’ll want to evaluate your lender like you would evaluate a business partner. Keep reading to find out how.
Choosing the best hard money lender
When you choose a business partner, you consider their background, their strengths, their weaknesses and whether you feel comfortable working with them. You’ll want to ask and answer similar questions about your lender.
Choosing the right hard money lender requires doing your research and asking good questions like the following:
1. Does the lender specialize in hard money?
If this seems like a no-brainer, that’s because it is. However, it’s easy to confuse private investment lenders or independent brokers with hard money lenders. The major difference is that hard money lenders function more like an institution with experts who specialize in servicing, originating and closing hard money loans.
To the untrained eye, these loans look simple, but they are actually quite complex and require proper structuring to make sure the lending process goes smoothly.
2. Is the lender local to the property you want to buy?
One reason big banks won’t usually fund flip projects, new construction or other projects that hard money lenders specialize in is because they don’t have the capacity or desire to evaluate and take risks on future value.
On the other hand, hard money lenders see the equity in the project as their protection against the risk and are in the business of speculating on future value. In order to do this successfully, proximity and local expertise are important.
Choosing a local lender makes the entire process easier. If you choose a lender who doesn’t know the market in your area, you may need to spend time educating them on the intricacies of your municipality and local trends instead of flipping your property.
“Real estate investing is a block by block business,” Kevin Rodman, managing partner at Asset Based Lending, said. “In certain cities, a couple blocks in either direction influences valuations by 15-20 percent. You want a partner that understands the difference and is familiar with the details in your micro-market.”
Additionally, a lender with boots on the ground can offer valuable insight into a specific neighborhood or property you have your eye on, including recommending trusted service providers and partners.
3. How quickly can the lender approve the loan?
If you’re on a timeline — and this describes every real estate investor — using a hard money lender can be hugely beneficial. Most hard money lenders process loans within seven to 14 days, and some can move even more quickly. Knowing how long the process takes is critical to being able to freely prospect for new deals.
Taking this one step further, speed is a necessity even after the loan is closed too. If the lender drags their feet reimbursing rehab or construction funds the project gets delayed, carrying costs add up, and the bottom line shrinks. Time is money in this business; taking too long to approve and fund a project costs everyone involved.
4. What are the fees involved?
Understanding the contract and paperwork can be one of the hardest, most tedious parts of real estate investing. Unless you have a law or finance background, it may be the least fun step, too. However, if you try to take shortcuts, you’re more likely to find yourself in over your head. So, be disciplined about understanding the fees.
Still, fees will vary widely. Never sign a contract you haven’t read fully, and insist on transparency as well. Be on the lookout for hard money lending companies who don’t offer a transparent process and detailed term sheet. They may be trying to coerce you into a bad deal with teaser rates. Insisting on transparency ensures you understand the terms of the deal before signing on the dotted line.
5. Where does their money come from?
This may seem like an unnecessary question, but when you think about it, it is essential to how they do business. Hard money lenders tend to fall into a few different buckets: They lend mostly their own money and keep the loans on their balance sheet, they sell all of their loans to institutional buyers, or they crowdsource the funds.
While there may be advantages and disadvantages to all of these options, a lender having their own capital plays a crucial role in their ability to move quickly and with flexibility since they don’t have anyone looking over their shoulders with the final approval.
Plus, like we saw during COVID-19 and any stretch of market volatility in recent history, reliability during uncertainty is precious. Lenders that rely on Wall Street institutions or raising capital for each loan will quickly pull the plug and suspend lending as their liquidity dries up, but balance sheet lenders can and will continue lending in accordance with their own risk tolerance and understanding of the local markets.
With these questions under your belt, you’ll be ready to enlist the help of the right hard money lender. Now all you have to do is find the right property!