How to Choose a Hard Money Lender

July 14, 2020

Hard money lenders, also known as private lenders, are different from banks. Because they are funded by private investors, you will find much more variability in the qualifications they impose for property and borrowers than among banks. Moreover, a hard money lender is not subject to the same banking and mortgage lender regulations that govern chartered banks. This allows hard money lenders to tailor loans to the needs of their preferred investments and geographic area of operation.

Characteristics of Hard Money Lenders

A bank’s role is to supply financing first by evaluating the borrower and the borrower’s financial state, including taking into account their debt compared to their income, commonly known as a debt to income ratio. Once those thresholds are satisfied then a bank would lend on the underlying asset.  They simply lend a percentage of the current value of the asset with the borrower bringing the rest to the table.  In general banks don’t like to lend on distressed assets because they don’t have mechanisms in place for evaluating the end value of a deal or monitoring the renovation of such a project. On the other hand, a hard money lender’s role is to supply financing by evaluating the borrower with simple criteria of cash in the bank and credit and then they dive into the future value of the distressed property after its fixed up, also known as the after repair value or ARV.

Threshold considerations in choosing a hard money lender might include:

  • Does the lender specialize in hard money loans? Unfamiliarity with the hard money loan process might lead to miscommunication and miscalculation by you and your lender.
  • Is the hard money lender local to the area where your investment property is located? If the hard money lender does not know the investment property’s real estate market, you may spend precious time educating the lender instead of flipping your property. Plus a lender with a footprint on the ground can give you valuable insight into a specific area or property.
  • Is the hard money lender a direct lender or a broker?  While both types of lenders can get you a hard money loan, generally a direct lender will be able to make decisions quicker and ultimately close faster since they have their own capital and make the decision in house.  In addition there may be less fees when using a direct lender since a broker typically makes a commission on top of what the source of capital is charging.
  • Does the hard money lender have written loan qualifications? Knowing upfront that you or your property do not meet the lender’s qualifications will avoid wasting time applying.
  • How quickly can the hard money lender approve and fund hard money loans? If the hard money lender takes too long to approve and fund loans, you might run out of time to secure alternate funding before the property is sold to someone else.
  • What is the cost of hard money lending? Hard money lenders typically have less overhead than banks. Nevertheless, hard money lenders do charge fees and these fees will vary.  The use of leverage, speed and ease of access to capital needs to be taken into effect when considering the cost of the loan.
  • How long has the hard money lender been in business? Hard money lending is a niche market that has legal, regulatory, and commercial processes that are unlike banks or mortgage brokers. An experienced hard money lender will reduce the likelihood of incorrectly prepared documents or mistakes in the application, approval, and funding process.
  • What is the hard money lender’s reputation in the community? Hard money lenders may serve a niche market, but they still earn a reputation with real estate agents, bankers, and real estate investors. A hard money lender with a strong business reputation will not only work with you in a professional manner but may open doors for you within the real estate investment community.
  • Does the hard money lender have any staff members with licenses or certifications? There are no national or state organizations that certify hard money lenders. However, every state regulates real estate brokers and lawyers, and many hard money lenders have licensed brokers and lawyers on staff. A hard money lender that has licensed brokers and lawyers is less likely to do anything that could jeopardize their licenses.

In addition to the way the hard money lender conducts business generally, you will also want to make sure your investment strategy and investment property match up with the hard money lender’s preferences.

Investment Strategy

Different hard money lenders may prefer specific types of real estate investing strategies. For example, a hard money lender might prefer fix-and-flip transactions while others prefer buy and hold transactions. As a result, you will find varying terms for hard money loans, including:

  • Duration: Although all hard money lenders intend their loans to be short term, the duration of loan terms will vary. Some hard money lenders are more comfortable with longer-term loans (on the scale of a year or more) while others prefer shorter-term loans (on the scale of less than a year).
  • Interest rate: Interest rates will vary among hard money lenders just as they vary among banks and mortgage lenders. Shopping around will help you find an interest rate that works for your project.
  • Loan amount: Most hard money lenders will require cash in the deal so that you have “skin in the game.” However, the size of the down payment will vary with different lenders. Stated in a more measurable way, the maximum loan-to-value ratio will typically run somewhere between 65% to 75% but different hard money lenders will fall at different points within that range.

Investment Property

Since hard money lenders focus on the asset and the transaction, many of the characteristics that you might use to choose a hard money lender arise from the lender’s familiarity and comfort with the type of property you want to invest in.

Thus, before you can choose a hard money lender, you need to target your investment properties. For example, some hard money lenders work exclusively with commercial real estate investors. Conversely, other hard money lenders only finance residential real estate transactions. Finding a hard money lender that understands your asset class and is comfortable extending hard money lending to you can speed the application process and reduce the risk of friction later.

This is particularly important if your proposed real estate investment does not fit squarely into the definitions of commercial and residential property. For example, some hard money lenders might balk at funding investment in undeveloped lots, churches, or agricultural land.

Choosing a Hard Money Lender is Like Choosing a Business Partner

An intangible factor in choosing a hard money lender is your comfort level with the lender and the staff that you interact with. A hard money lender invests time and money into your project, so you need to be able to trust each other and work together to reach a common goal.

Unlike a bank that only wants to receive its loan payments, a hard money lender truly wants you to succeed because your success means that the real estate investment project will be profitable, and just like you as the investor, the hard money lender has earned a return on the investment. In this respect, you and your hard money lender are in a symbiotic partnership. Your hard money lender provides the financing to fund your real estate investment and you put the hard money lender’s money to work in order to earn a profit.  A successful deal means you as the investor hopefully comes back to utilize the lender’s money again on another project in the future!

To discuss whether Longhorn Investments is the right hard money lender to choose for your project, contact us.