Hard Money Lenders
By Steve Gillman - 2007
Hard money lenders make short term loans (usually 24 months
or less), and often charge a fee of as much as five percent or
more of the loan amount, and an annual interest rate of
up to fifteen percent or more. Why would you want to go to such
a lender? Because they take risks and get the money to you fast.
These kinds of loans are typically used for the purpose of purchasing
and rehabbing houses for a profit, and banks are not often willing
to help you out in this area.
Consider the following scenario: You want to buy a house as
a fixer upper project. The sellers is looking at a market full
of buyers who put in their offers contingencies like waiting
for the sale of their house, or applying at various banks and
other lenders. But because you are willing to use hard money
lenders, and you already have a working relationship with one
or more, you get to say "I can close for cash in a week
or less." Now that gets the seller's attention right away.
It can even mean getting a property for less than other bidders
are offering, since the seller knows you will close -- and fast.
How Hard Money Works
Every lender is free to make his or her own rules, of course,
but typically you can borrow 65% to 70% of the ARV value. That
stands for "after repair value," which will be determined
by their appraiser. That's another advantage of borrowing
this way. Banks generally only loan based on the existing value,
but hard money lenders understand that the property will be worth
more when you are finished with it. The loan will also be based
on the property itself more than on your credit rating, another
reason you may want to go this route.
Here's a quick example:
Suppose you find a house that needs some work. You make an
offer for $100,000 and you expect that once you have fixed it
up it will be worth $160,000. Note that it is very important
to have a clear plan in mind and so be able to estimate both
your costs and the eventual sales price with some accuracy. Hard
money lenders will have to agree with your basic estimates in
order to be interested. Experience and/or good research can help
a lot here.
One of your lenders agrees with your assessment of the deal,
and so lends you $112,000, which is 70% of the projected ARV
of $170,000. Notice that you actually get more than 100% financing
based on the purchase price. This is common, but it is also common
for part of the money to go into a escrow account to be drawn
on for repairs and other expenses as necessary. In a case like
this that might be $20,000 or at least the $12,000 that exceeds
the purchase price.
In a month you have made the necessary repairs and improvements
and a couple months later you have sold the house for $158,000.
Your total expenses for repairs and improvements amount to about
$11,000. Holding costs (property taxes, insurance, and utilities)
and selling expenses are about $9,000. You also paid $5,000 as
a loan fee and another $5,000 in interest. That's an expensive
loan, but on the other hand, all that really matters is whether
it enabled you to make a decent profit. In this example, the
numbers look like this:
Buying Costs: $2,000
Repairs and Improvements: $11,000
Holding Costs: $1,000
Selling Costs: $8,000
Loan Fee: $5,000
Subtracting that from the sales price of $158,000, we can
see that you made a net profit of $26,000 on a deal that perhaps
no bank would have lent on. That's why people use hard money
lenders. The cost of borrowing is not a problem as long as you
make a profit in the end.
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