If you want to purchase a real estate property, it’s not as if you can bring a suitcase full of cash and sign the property documents. That probably happens only in the movies. So what do you do if you don’t have adequate funds? Well, for starters, you’ve got to be creative and think outside the box.
What options are there?
For those who cannot acquire financing from traditional sources such as a bank or credit union, there are a couple of other options. Crowdfunding, home equity loans, FHA 203K loans and private loans are a few alternates. But one that is gaining considerable traction is HML (hard money loans).
What is HML?
Some people think that hard money loans deal with plain old ‘hard cash’. Though the two may sound familiar, this is not the case. Hard money loans are entirely different from hard cash. Therefore, it’s important to understand the distinction between cash (which is your own) and hard money (which is someone else’s cash).
Hard money lending involves acquiring loans for real estate purposes. They are typically used by investors who have experience in buying a property and selling it after renovations to make a quick profit. They are short term loans with high-interest rates. Though they are easier to obtain, has less red tape, and funds are released quicker, HMLs are not for everyone. They come with a few hidden risks.
Why are they called ‘hard’ money loans?
There are a couple of theories behind how the name was derived. Some claim it’s the ‘hard’ assets underlying the loan, such as real estate property, that is used as collateral for funding.
Others believe the name implies that these loans are riskier and may be harder to pay back. Interest is typically higher than those at a traditional financial institution, with rates ranging between 7.5-15%. More importantly, it must be repaid within a specified period. Otherwise, a penalty can be incurred.
Some deals can be closed without a loan or a financing contingency. The buyer has enough funds for an all-cash payment, either through cashier’s check or an account transfer. Sometimes all-cash deals consist of borrowed capital. A buyer can tap into a retirement fund or take out a loan on another property.
Can hard money be considered cash?
There is more to it than just the terminology. It depends on how you look at a particular situation. Remember, there are always two sides to a coin. So let’s have a closer look at both sides of hard money loans. Consider the following situations:
Good as cash
When a seller wants cash for his property, it’s possible that a buyer has only a portion of the amount that is required. For example, a real estate property is on the market for 100k, and you only have 30k. The seller is interested in selling the property for cash and wants to collect payments quickly. If you apply for a hard money loan, they typically lend you up to 70% of the purchase price and release funds soon. So the remaining amount that hard money lenders are providing to finance your real estate property is an ideal way to close the deal quickly. In this scenario, hard money can be considered to be the same as ’cash’. You’re guaranteeing to buy the property without delays.
Not the same as cash
A hard money loan is a contract where an institution loans you money for a specific purpose. Here, the loan applies to real estate, and it comes attached to a whole list of clauses. But one of the most significant differences between cash and HML is that once cash is deposited in the seller’s account, the sale is final. However, in the case of an HML where funds may be released through monthly installments, there is a risk of stopped payments if there deal between the borrower and lender is cancelled for some reason.
Proof of funds
As mentioned above, there are several routes people can take to acquire financing. Private loans generally refer to funding obtained through a family member, friend, business partner, etc. Though they offer flexible terms and a lower interest rate, they tend to be harder to find than hard money loans. Therefore, when a lucrative property comes on the market, it’s not an opportunity that you should let slide by simply because of the lack of enough capital.
At the end of the day, many sellers will be interested in the proof of funds. For instance, if you acquired a loan through your bank or credit union, you would need to submit a letter or document certifying that you, the buyer, have the necessary funds to close the transaction. Similarly, if the funds were secured through a hard money lender, they would also provide a proof-of-funds letter. Remember that an HML is a collateral-oriented loan secured against the property you are interested in buying, where most will give a 60% to 80% loan-to-value ratio (LTV). Why opt for an HML?
Speed is vital in the real estate market, for both the buyer and the seller. It’s the only way that investors can snag lucrative deals. And homeowners are often anxious for quick and virtually guaranteed settlement.
Bad credit doesn’t matter
Here’s one advantage that many individuals bank on. HMLs focus on the collateral property instead of the borrower’s credit. However, they may charge higher interest and fees as well as lend at a lower LTV to those who lack experience in fix-and-flip properties or are considered high-risk borrowers.
Ideal for financing renovations
Hard money lenders typically cover 100% of the costs associated with renovations costs. Depending upon the agreement, funds can be released in a series of installments.
Down payment flexibility
While traditional money lenders do not permit applicants to utilize borrowed funds for the down payment, HMLs are flexible about down payment policies. They focus on collateral instead. After all, they are in business to make money off of real estate loans.
Distressed or dilapidated properties don’t matter
The type of property, including its flaws, are overlooked. The loan is secured based on the as-is value in today’s real estate market as well as the after-repair value (ARV).
There are rules associated with HMLs. If you do not comply with the terms of the agreement, you are at risk of facing foreclosure. The most important aspect of the loan is the structuring and exit strategy. Once you borrow and your signature is on those documents, expect zero flexibility. But having said that, enhance your opportunities and make the most out the flourishing real estate market.
A hard money lender will scrutinize the property to make sure it’s being purchased below market value. You need to prove that you will be able to create more equity by renovating the property. Provide a schedule for the work you plan to do. The quicker you complete the project and repay the loan, the more profitable it will be.
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