Hard Money Loans – An Investment Tool
by Noah Bruegmann | Sep 07, 2015
Hard money loans, sometimes called private money or trust deed loans, are real estate loans from a source other than a regular financial institution. They are generally more expensive than conventional loans, but also considerably more flexible. For a more in-depth discussion of what hard money loans are, check out Alternative Loans – Hard Money Loans – What are they?
Not just for subprime borrowers
In common real estate glossaries, these loans are often portrayed as a last resort for buyers with poor credit. While they are appealing to subprime borrowers, savvy, credit-worthy real estate investors view hard money loans as a way to create highly profitable investments. Even at higher prices, there are a number of cases when hard money loans offer distinct advantages over conventional loans.
Let’s say you want to invest in a house that is run down, but in a good neighborhood, and has just come on the market for $200,000. You are confident that if you buy the house and spiff it up a little with new paint, carpet, and landscaping, you can resell the house for $275,000 with a $12,000 investment. But, you only have $100,000 of cash on hand and will need a loan.
If you suspect competition to buy this house to be stiff (a common reality in today’s low inventory market), you could increase your chances of closing the deal by making an all-cash offer with a short closing. By offering $200,000 to purchase with a 15-day inspection period and closing within 21 days with no loan contingency, you can make your offer stand out without paying a higher price – with just one problem. Usually, there’s no way to get a conventional loan to close in 21 days. A conventional lender needs all kinds of paperwork and verifications in addition to an appraisal from a specific type of appraiser. Sadly, it just isn’t going to happen in 21 days.
Low overhead and nimble
Many hard money lenders can and routinely do make loans that quickly, however. Hard money lenders are usually not big financial institutions; instead, they are brokers with low overhead using private investor funds. This structure allows them to make a decision within a few days and take the necessary steps to close quickly. Some hard money lenders can close loans within 4 or 5 days from the initial borrower contact and request.
Bridging the loan gap
In the lending universe, the hard money lender bridges the time gap. Think of conventional lenders as being a Ford or Chevy and the hard money lender as being a Porsche. The Ford or Chevy costs less, but the Porsche can go a lot faster. Some real estate investors take out hard money loans for high value projects not so much because they want the loan faster, but because they want a quick, hassle-free loan. In the same way we might buy a bottle of soda for a premium at the convenience store versus making a trip to the grocery store: We can get in and out of the convenience store quickly and without a hassle.
Similarly, a builder, developer, or someone who buys, fixes, and resells houses (a “flipper”) may be willing to pay a higher price to avoid the hassle of extra paperwork and requirements imposed by a conventional lender. For busy contractors and investors, time is money. You can simplify your life and cut the amount of time needed to get a loan by half or two-thirds with a hard money lender (especially if it is one with whom you have previously gotten a loan).
The magic of compounding
Investing isn’t just about the absolute number of dollars returned for the number of dollars invested; it’s about the time it takes to get those returns, which dramatically impacts the value of an investment. In an extreme example, you’d probably never agree to invest in an opportunity paying out five hundred years from now, even if that payout could be a billion dollars.
More realistically, if you can make an investment that returns a moderate 3% each year and then reinvest including the 3% earned, you’d need to find an investment that would return 16% in five years to be better off making the five year investment. For this reason, the faster a real estate investment can turn around, the better.
The standard in the hard money industry is to have no pre-payment penalties on loans (although there are exceptions). This structure means that a developer or flipper can invest, navigate whatever construction requirements or delays are necessary, and exit their investment as soon as they are ready. This kind of flexibility can speed up investment turnover, which leads to faster compounding.
Of course, none of these advantages help much if the cost of the loan is significantly greater than the cost of a conventionally available loan, as it gobbles up all additional value created by your investment. You should always explore your options and use your best judgement when deciding which loan solution to choose.
One way to be sure that your costs are staying low is to connect with hard money lenders who are comfortable lending for projects similar to yours.
LoansEasily is an online tool that helps match your loan needs to lenders who have an appetite for similar projects. Getting multiple quotes helps keep your costs low and your investment returns high. Check out their website here: www.LoansEasily.com
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