Hard Money, and How Can You Refinance a Hard Money Loan?
by Christopher Levarek
“The single most powerful asset we all have is our mind. If it is trained well, it can create enormous wealth.”
- Robert Kiyosaki, Rich Dad Poor Dad author
If you're a real estate investor or a business owner looking for a quick source of funding, you may have heard of hard money loans.
If not, hard money loans are short-term, real estate-secured loans that are frequently used by investors who need to close deals quickly or who have credit difficulties that make it difficult for them to get approved for conventional bank loans.
As we’ve used this type of loan multiple times, I wanted to share just how these have helped our real estate projects and investments. This blog will explain how hard money loans operate and offer two examples on how to use them.
How do Hard Money Loans work?
A hard money loan is a type of loan that is typically issued by a private lender, investor or hard money lender. Real estate is used as collateral to secure the loan, so the borrower is using their property as security. Hard money loans often have a term of six months to twenty-four months.
The value of the asset used as collateral determines the loan amount, with the lender typically contributing 50% to 70% of the asset's worth. Sometimes you can get up to 90%, including renovation costs or using LTC (loan to cost) instead of just the existing property’s value (LTV or loan to value).
How Does Hard Money Lending Operate?
In comparison to a standard bank loan, the application process for a hard money loan is often quicker and simpler. Lenders typically assess both the borrower's ability to repay the loan and the property being used as collateral. Because the lender might not do a credit check, unlike typical banks, borrowers with bad credit may nevertheless be eligible for a hard money loan.
The lender will provide the money to the borrower when the loan has been granted so they can use it to buy the property, make upgrades, or for any other company needs. Regular loan payments, which normally include both principal and interest installments, will be expected from the borrower. Also, certain lenders could impose extra charges like origination fees, application fees, or prepayment penalties.
The lender may foreclose on the property and sell it to reclaim their investment if the borrower does not make loan payments on time. Nevertheless, the majority of hard money lenders favor collaborating with debtors to come up with a plan that enables them to pay back the loan while avoiding foreclosure.
To demonstrate how a hard money loan operates, consider the following purchase:
Real World Example #1, The FLIP:
Imagine you're a real estate investor wanting to spend $100,000 on a property that needs work. Within six months, you intend to refurbish the house and sell it for $150,000. You lack the necessary funds, though, and your credit score is too poor for you to be approved for a conventional bank loan.
You could make a hard money loan application to a private lender in this circumstance. After assessing the property and your capacity to pay back the loan, the lender makes you an offer for a loan of $70,000, or 70% of the value of the property. With a 12% interest rate and a 2% origination fee attached to the loan, you'll have six months to repay $82,400 ($70,000 plus the expenses of $8,400).
You can purchase the home and start improvements right away thanks to the hard money loan. You placed the house on the market after finishing the improvements in three months. You receive a $150,000 offer within two months and sell the house. You pay back the hard money loan with the sale's proceeds, netting a profit of $67,600 ($150,000 - $82,400).
In this case, a hard money loan allowed you to swiftly buy and refurbish a house even though you lacked the necessary capital and didn't meet the requirements for a conventional bank loan. The quick turnaround and profit you were able to generate on the property sale more than made up for the harder money loan's higher interest rate and costs.
In other scenarios, you can refinance a hard money loan into a traditional loan, thus pulling out all the equity or some of the equity while paying off the existing loan. This is something we do quite frequently. W
e use a hard money loan into the property and fix it up then refinance into a traditional loan, like this…
Real World Example #2, The Refinance:
Let's imagine that you paid $100,000 for a home with a hard money loan and then finished the repairs. The hard money loan has a term of only six months, and despite putting the house on the market and receiving a $150,000 offer, you haven't been able to sell it in time to pay back the debt. You need to find a means to refinance the hard money loan because you might now go into foreclosure.
You might think about refinancing the hard money loan in this case with a conventional bank loan or another form of finance. You'll need to locate a lender who is prepared to offer financing based on the property's value rather than your income or credit rating.
You can refinance the hard money loan and obtain additional cash based on the equity you have in the property by applying for a cash-out refinance loan, which is one alternative. Let's assume that after improvements, the property is valued at $200,000 in this instance. Up to 80% of the property's value could be requested as a cash-out refinance loan, giving you a loan amount of $160,000. The extra $60,000 might be used to pay off the hard money loan and take care of any other property-related costs.
This might be worthwhile if you are looking at keeping the property long term especially if you can pull out all your costs or even get cash back! It does take some analysis to make sure your costs plus the hard money loan will be covered by the new traditional loan amount.
In any scenario, it's crucial to conduct research and identify a reliable lender with expertise working with borrowers in your circumstance. It's essential to work with a lender who can walk you through the procedure and help you locate the best financing solution for your circumstances.
IN FINAL
For real estate investors and business owners who require immediate access to capital, hard money loans can be a beneficial tool. But compared to conventional bank loans, they have higher interest rates and costs, so it's important to weigh all of your options before deciding to take one out.
Make sure to do your research and engage with a trustworthy lender who has expertise dealing with borrowers in your circumstance if you're thinking about taking out a hard money loan.
Happy Investing!