no doc hard money loans
A hard money loan is a generally short-term loan that many flippers use to be able to get in and out of projects while leveraging the most they can for each one of them.
Pros And Cons
Most hard money loans are for only three to four months. They have very high interest rates compared to a traditional thirty-year amortized mortgage, but they are utilized because they allow the borrower to purchase properties that normally could not be afforded or would require a longer contract negotiation.
For example, suppose a property that costs at least a million dollars and most people just do not have a million dollars in cash, and if they had to go through a traditional route of obtaining a long-term mortgage, it would take over a month to close escrow.
In a hard money loan, the deal is only possible because the sellers are in some kind of financial distress and the prospective buyer is able to close quickly on these deals with the financial support of the lender.
Being able to use a hard money loan allows the borrower to purchase a property and close the operation within ten to fifteen working days, whereas a traditional loan can sometimes take over thirty days.
Typically, if you are brand-new in the real estate market, then you probably cannot get as much leverage as an experienced investor can, so you are looking at obtaining a hard-money loan at 85% LTV or 90% LTV at the best. What does that mean is that if your loan to value ratio it is either 85% or 90%, so if you have a million dollar property, then the maximum that someone will loan you is either 850 thousand for an eighty-five percent LTV or 900 thousand if it’s 90 percent LTV. The remaining money should be brought by the borrower as a down payment.
Now what does it cost to get a hard money loan? Well, for a brand-new investor you are typically going to see rates at ten percent annualized and two points for the origination. That means for your $90,000 loan a ten percent of that nine hundred thousand is due every year and an annualized rate, so after holding that loan for a whole year you have paid ninety thousand dollars in interest payments.
Yes, that sounds like a very expensive deal and much worse than a traditional long term mortgage, but it is worth it for the investor who is going to make two hundred thousand dollars on the back end.
What are origination fees? Origination fees are about 2% of the loan, and are the fees that the hard money lender charges you to originate the loan. The origination here means to create the loan for you, so using “creation” as a synonym with “origination”.
The hard money lenders have people in the back-office underwriting the loan, sales people who are creating the packages for the borrower, lawyers drafting a contract, and working with you to close on time. All these back office services cost money and finally the borrower will be paying for them in a line item called “origination fees”.
Most of them are 2% for new investors so for on a $900,000 loan on a 1 million dollar property and 2% origination fees you will be paying $18,000 just to close on the loan.
But they do not charge you this 2% of origination fees. What they actually do is that they just give the borrower a smaller loan, so instead of giving the investor that $900,000 loan expected, they are going to give the borrower a loan for $882,000 (eight hundred eighty-two thousand dollars).
Usually, the consequence of this is that the borrower has to come up with more money to close on the property in the first place.
Funds As Down Payment
So when you come as an investor / borrower to a closing table, what kind of funds do they need you to have?
Obviously, they want the borrower to have the 10 percent or 20 percent as the down payment for the property, but you also are required to possess enough liquid capital to pay for the origination fees you ought to have enough money to pay for all other buyer-closing costs like notary fees, and other miscellaneous items that they charge the borrower when closing the deal for the property. Many borrowers include these miscellaneous items inside the origination fees line item.
When you are considering your hard money loan, you also have to be careful if they have a prepayment penalty.
Sometimes they will charge you for a predetermined number of months of payment regardless if you close it through a complete payment in one or two months, so some investors do something called “wholetailing” where they buy a property with a hard money loan, and they put it back on the market without doing anything, and they sell it within a short period of time.
If you have a loan that has a four-months minimum that you have to pay those four months worth of interest payments no matter what, that is a contract clause of prepayment penalty.
Hence, just be careful when you are getting a loan to ensure that there is no prepayment penalty within the terms defined by the lender, or if there is such a clause, that it does not affect you because you have planned to spend a long time working on that project, presumably, a construction or renovation project, anyway.
So hard money loans are typically for the real estate business and specifically for house flippers people doing fix-and-flip.
Business Case From The Investor Point Of View
Why do you need a hard money loan? What usually happens in the real estate business is that the investor desires to flip a house. The investor finds a beautiful house at a 250 000 purchase price at an auction, and he needs to close very quickly on this house, otherwise the auctioneer may close the deal with another buyer.
Unless this borrower has 250 000 cash in his pockets to put down, he will require another source of money and that is usually where hard money lenders step in.
Typically, hard money lenders can obtain money for these investors very fast. Sometimes it is five to ten days, the time period in which they can have the money in your pocket or better said, available for you.
If you have a relationship with these lenders, they can close in three to even five days or give you proof of funds for you to move forward with the seller or auctioneer.
You can really work with them to be your financial partner to make sure you grab the best hammer price at the auction, so they specialize in speed of getting deals done fast.
Now why are they called hard money lenders? It is because their terms are a little bit higher than usual. It is hard money because it is a little bit expensive money, however it gets the deal done. The borrower will not care much because the deal can be closed faster with the seller or auctioneer.
So for example on this 250 000 dollars house from our example, let’s say they do a hundred percent of the deal (100% LTV in our hypothesis) to purchase the home.
Your plan, as an investor, is to perform the renovations of the house spending, let´s say, fifty thousand dollars ($50,000) in renovations and you’re gonna sell it for four hundred thousand dollars. Therefore, you bought it through a hard money loan for the aforementioned 250K, you are going to put 50 grand in ($50,000) and you are going to sell it completely refurbished for $350,000. This represents earnings for $50,000 on this transaction.
Requirement of a First Position
The lender will normally provide the funds to the borrower with the condition that he takes the first position on the mortgage of the property. There are exceptions to this situation that will be studied below. But in almost all cases, the condition of the hard money loan is to take the first position in the mortgage loan.
I will explain you now how positions work in mortgages derived from hard money loans. For the mortgage creditor, the first position on the property means that in the capital stack they get paid out first.
There can be more positions such as second and third position. These positions define the level of priority of the mortgage creditors.
What that means is that if the house or real estate object goes into foreclosure and gets sold, the first position person gets paid a hundred percent first. Regarding the mortgage creditor second position, if there is leftover money, then gets paid some leftover and then third position continues according to the priorities in the capital stack.
As we go down in the capital stack, the price of money gets more and more expensive because the prospective creditor who will assume the second position is engaging on a much higher risk. A first position mortgage right now is like a 2,5% up to 3%.
For a second position they might charge you a four and a half percent up to 6% and then a third position can be easily more than 10%
For example, a hard money lender, who can provide you with 250 grand: they want a first position on the mortgage, meaning they essentially “own the house” (not legally, of course, as the “house” is the collateral of the mortgage and is still in the property of the debtor). If the debtor does not pay them back they are just going to take the house themselves.
Typical LTV In These Loans
A hundred per cent loan-to-value ratio (expressed as 100% LTV) is a ratio which from the lender’s point of view is a little bit risky.
Why? What happens if this house drops its price? imagine that the entire stock market drops 20 percent overnight? The borrower, who did not invest any money in this 100% LTV example, would simply walk away from the deal. The lender, instead, they will have their rights in the collateral, but they may also have losses that are about twenty per cent or a bit more.
That is why you will not see in the market 100% LTVs. More common could be an 80% or even more frequently, a 70% LTV.
In this case, the lender will grant the funds to the borrower up to a 70% of the purchase price, assume fewer risks, while securing themselves the first position in the subsequent mortgage loan. The investor or borrower has to perform a down payment of 30% of the purchase price and will receive the funds to enable the purchase from the seller or auctioneer.
In this way, the lender ensures that the investor does not walk away from the property because he has a good 30% of his own money in the property.
The previous evaluation depends on the hard money lender you are working with. If you have worked in the past with the lender, he may take more risks and go with a 90% LTV.
Fast Turnover and the Internal Rate Of Return
For this topic, we continue with our example: The lender provided 250 thousand dollars to the investor, while securing themselves a first position in the subsequent mortgage loan. The investor plans to invest in the home renovation about 50K, reselling it for 400K and obtaining a good revenue.
Hard money lenders typically want the investor to complete this “flipping life cycle” short term. They do not want to engage in a contract for over a year because it hurts their returns, it hurts their IRR (Internal Rate of Return). The faster you receive back the money, the higher the IRR you ge.t
Some lenders will want a monthly payment while some lenders will say: “I want a balloon payment at the end of six months“, so six months and one day “I want my 250.000 of my loan back, plus my interest rate of 12 percent“.
The faster the turnover, the better for the hard money lender.
Typical Contract Terms In Hard Money Loans
so then what are some typicalterms that they have on the loan howmuch do they charge what’s percentagepoints all that kind of stuff?
a lot of hard money lenders will do this: they’ll say hey i wan ta couple points up front let’s call it three pointsand eleven percent interest. so three points of 250k three percentage points, would beseventy five hundred dollars they want up front.
if you back out of the deal last second they’ve done all this work they want to get paid.
nowyou can negotiate with them who’s goingto pay for the title insurance who’sgoing to pay for the legal docs who’sgoing to pay for all that’s negotiableup front.
sometimes that’s inside of the points. they’ll say that of the 7 50 0we will cover the legal docs but you got to cover title, or we’ll cover title you cover legal docs whatever it is sometimes they’ll say hey you’recovering everything else we still want three points up front to get us into the contract to make sure we do all this and work but that’s what they mean by percentage points
and then wehave 11interest and depends on the firmsometimes they charge 11 points they’llsay heywe want 11 percentage points whetherit’s in six months or three months ortwo months that we want 11 pointssome firms will say hey we want 11interest annualized so on this loan it’sa sixmonth loan 11 percent.
that really means thatyou’re paying 5.5 because it’s an annualized number againit depends on whom you’re dealing withand who you’re talking with or from a lender’s point of view how you want to pitch your deal
so like i said beforethisthere’s a lot of negotiation that goeson here how many points how manyinterest and a lot of hard money lenders, though if you’re on the real estate sideof things they usually have their terms laid out and they say take them or leave them that’s typically what they say they saythis is wedo three points we do 11 percent we do75 like this. this is the deal take it or leave it.
you can go to somebody else there’s plentyof hard money left this is what we willdo for you but we will have money inyour pocketin seven days
and yes i think you canpush them on a few things but a lot oftimes they havea lot of deals and they they want to be prideful and they’ll say nah just go tosomebody else they’ll kick you out andthey want to have that realm so they arenot someone has a reputation that’snegotiated with all right
back to the example okay 250 grand theygo downyou let’s say you bought the house itgoes great you put in 50 grand of yourown or you use whatever else financingand sometimes hard money lenders willgive you a line of credit you can drawdownto do the flip for that other 50 grandwhatever let’s say though you put yourown money in 50 grand and you sold itfor400 thousand dollars awesome so you madea hundred grandprofit on this house flip and chip but you’vegotta still pay back your hard moneyloan so you pay back the principal onthe sale 250 grand is back and nowyou’ve got to pay their feesyou’ve already paid three points upfront you’ve already paid the 7 500 upfrontand now you’ve got to pay 11 percent let’s callit 11 percent interest annualized so that wouldbe 5.5percent just points on 250 grand whichis 13750
you pay them13750 they’re happy they got theirpointsthey got everything they got their moneyback and now you get to keep about 80grand from this deal because you paid atthe beginning you paid 7 500 you paid 13,750 later, also here you keep about 80about 80 grand from this deal
Once the hard money lenders know you well, they could be doing a 100 loan to value for doing hard money loans. However in general they are very cautious. Despite the foreclosure, the house has to be put on sale and probably accept a loss.
To avoid more risks, lenders will do 70 or 80 percentl oan to value so 250 grand I’ll do 80of 250 grand so you got to put your money in there but then on renovations, i’ll give you let’s call it a 50 000line of credit and you can draw it down10 000at a time and i want to check up on thehouse i want to make sure the money isgoing into the house: i want to make sure that it’s going intothe asset that i have a first position lean
onthat’s a one example for hard moneyloans broken down that’s probably themost simpleway to explain it how they work on both angles and how both sides think of it.
nowsome lenders to go a little bit deeperi f they’re let’s say that another house okay different example it’s a milliondollar house somebody already has a first position let’s call it 300 000on this house
So, well, what i will do as a hard money lender is say i want to be in first position I’m not going to take second position because it’s too risky right if you take a second position you are at mercy to the first position the first position usually has all the rules and rights to decide what to do so if they don’t want to sell, they don’tsell if they want to hold on and renovate or upgrade the house, they have pretty much all decisionmaking on from that first position
nowit depends on the documents how you workwith them but usually the first positionhasall of the rights and rules and candetermine everything so it’sit’s hard to be in second position
somefunds do i know a fund they only dosecond positions and this is how they doit okay they come inat a second position or they come infirst but they willbuy out the first position so what imean by that is this they will come inthey’ll say hey you need a loan forlet’s call it four or five hundred thousand dollarsyes we’ll give you a loan for 500 grandand we’re alsowe’re gonna do an extra 300 000 and buy out this person and take out their positionand nowwe assume a first position on thisproperty so now the lender is into thisproperty eight hundred thousand dollarsbut still it’s a million dollar propertyso if the property lost twenty percent of its value overnight because the the real estate market crashed it’d still be okay because theycould still sell it for 800 000so that’s one way that a lender can getinto a dealif there’s a first position on it theyjust buy out the first position and assume the first position
Where you get your hard money loan you also have the option of getting a construction loan. Construction loans are funds that the hard money lender will lend to you in order to do the actual project, so for a million-dollar property, if you are going to spend a hundred thousand dollars into it, obviously you could have the cash and you could just do the work yourself or you asked for a construction loan.
nowconstruction loans on hardware loans area little bit different because theydon’t just give you a hundred thousand afee to go play with what they do is theyhold one hundred thousand dollars intheir bank accounts and they give itback to you as a reimbursement they dosomething called draws
when you go datahard money loan you provide a scope ofwork you tell them what you’re going todo to the project and how much each lineitem will cost and what phase you’ll bedoing it in and you can ask for one twothree or four different drawers
nowdrawers are interesting because you haveto go in there do the work first andthen you get reimbursed for that money
say you have four different drawers eachone $25,000 worth you have to show toyour hardware lender that you completelythat first quarter of your project havethem send an inspector in to look andmake sure that all that work is done andthen they’ll pay you $25,000
construction loans you look at crazy toobecause some companies they charge yourconstruction loans on day one eventhough you don’t actually get that moneyon day one what does that mean it mean
sthat when you’re getting your loanyou’re still going to pay that 10%annualized rate and two points on that$100,000 even though you’re not gettingthat money on day one
that’s why personally I don’t getconstruction loans if I can help it Ithink they’re kind of a waste of moneyand I’d rather just have that liquidcapital so I can do whatever I wantwithout having to rely on them to fundmy deal
because let’s say that you havean inspection done and the inspectordoesn’t agree that you did the work wellnow you’re out of your pocket and youneed a fix to work with money that youmay not have because you’re overleveraged versus if I had the capital incash I could just fix it myself and yeah
the worst part again is that they chargeyou on day one so let’s say you get yourloan on January 1st they’re gonna chargeyou that 10% interest on your hundredthousand dollars even though you mightnot even get your draws until March orApril which is crazy
Now there’s abalance between your interest rate andyour origination fee and some peoplewould say that you know if you’re gonnado a very fast project go for a lenderthat will give you a loan at a very highinterest rate but very low originationfees
say that you’re gonna complete yourproject in one week who cares what theinterest rate is annualize if yourpoints are like zero but if you’re gonnaturn your project on in a week andyou’re still paying two points, well itmay not be worth it for a lower interestrate because you’re not capitalizing onthat time now
when you get a hard moneyloanthey’re gonna ask for some documents byyourself for the most part they look atthe property itself.
obviously they wantto see the address and they want to seeneighboring comps their own underwritingteam will probably do that comes forthem so don’t worry too much about thatbut you wanna be able to justify why youthink this is a good deal to them sothey’ll go and you the money in thefirst place
they want to see you have acredit score of about six thirty orabove under that they’re gonna startcharging you more interest rate morepoints or they may not give you the loanat all
make sure you have some kind ofgood credit history to be able to getthese kind of loans
they’re gonna wantto see again a scope of work they wantto see what kind of work do the propertywith the actual numbers attached to itso it’s good to get a contractor to cometake a look at the property and give youan accurate bid before you actually geta hard money loan
and they also want tosee a sheet of your experience they wantto see if you have closed on differentproperties in the past is this your veryfirst project don’t lie tell them thetruth but if you have more experiencelet’s say ten projects or more in thepast two years they’re gonna give you asignificant discount because they trustyou and they think you’re able to do theproject as you said you will
they’realso gonna wanna see some big statementsfrom you probably from the last one ortwo months and that just to show yourliquidity liquidity meaning the moneythat you can use right away whether itbe stocks bonds mutual funds or straightup cash
they don’t want to see the moneyyou have in real estate because you’renot gonna be able to sell your realestate and use that as cash right awayso watching liquidity downpaymentconstruction costs closing costs and sixmonths of your monthly payments
I haveto get all that wrapped up they shouldbe other clothes in 10 to 15 businessdays and they can probably go evenfasterfor an emergency
I am David, economist, originally from Britain, and studied in Germany and Canada. I am now living in the United States. I have a house in Ontario, but I actually never go. I wrote some books about sovereign debt, and mortgage loans. I am currently retired and dedicate most of my time to fishing. There were many topics in personal finances that have currently changed and other that I have never published before. So now in Business Finance, I found the opportunity to do so. Please let me know in the comments section which are your thoughts. Thank you and have a happy reading.