Here Are The Requirements For A Hard Money Loan

PUBLISHED Nov 20, 2022, 6:15:19 AM        SHARE

imgThe Free Financial Advisor Blog

Hard money loans are one of the more popular options for buying fixer-upper homes to renovate and resell for a profit. While there are alternatives available – such as using a traditional or renovation mortgage – hard money loans usually fund far faster and are less restrictive. If you’re considering a hard money loan for an investment property purchase, here’s a look at what hard money loans are and the typical requirements for a hard money loan.

What Is a Hard Money Loan?

Hard money loans are non-conforming financing options that are typically used to purchase commercial or investment properties. These loans aren’t available through traditional lenders like banks and credit unions. Instead, private companies or individuals may fund the loan.

As with a mortgage, a hard money loan is connected to the property, allowing the property to serve as collateral. However, they fund much faster – often closing within just a few days – and have less stringent requirements in many cases.

The interest rate associated with a hard money loan is commonly much higher than traditional lending alternatives. Additionally, the repayment term is far shorter. While mortgages usually have 15 or 30-year repayment periods, hard money loans may only allow a few years.

Since house flippers typically aim to renovate and resell an investment property quickly, the shorter repayment term isn’t inherently problematic. As long as the investment property sells within the repayment period, proceeds from the sale cover the cost of the hard money loan and any associated interest, and the investor keeps any remaining profits.

Hard money loans may also work for rental or commercial properties where anticipated income generation makes paying off the loan on time plausible. In this scenario, investors may aim to complete any required builds or renovations to ensure the property meets the livability or value requirements set forth by traditional lenders, giving them an opportunity to refinance the hard money loan into a typical mortgage upon completion.

Requirements for a Hard Money Loan

As with all lending products, the requirements for a hard money loan may vary depending on the issuing party. However, there are some more standard requirements that most borrowers will need to meet. Here’s an overview of the typical requirements for a hard money loan.

Sizeable Down Payment

Since hard money loans are usually riskier for lenders, the down payment requirements are commonly higher. For example, while mortgages may only require up to 20 percent, a hard money loan may have a minimum down payment requirement of 30 percent.

However, precisely how much the lender needs as a down payment does vary, including based on the borrower. If the borrower has a substantial history of repaying hard money loans on time through their investment projects, the lender may require a smaller down payment in comparison to what they’d expect from a less experienced investor.

The state of the property being purchased is another factor that may influence down payment requirements. Additionally, the buyer’s plans for the property could also play a role. For home flipping, local market conditions may cause down payments to rise or fall, for example.

Cash to Cover Fees and Insurance

Along with a down payment, buyers need additional funds to cover any associated fees or insurance needs in cash. This includes handling underwriting expenses, closing costs, and property insurance, at a minimum. Other fees may also be part of the equation, so investors should look at what the hard money lender specifically requires to ensure they have enough money to address these expenses.

Liquid Cash Reserves

Most hard money loans are used to purchase properties that require renovations or land for building a new structure. Since that’s the case, buyers need liquid cash reserves to successfully handle the project and meet any payment requirements for the hard money loan.

Generally, liquid cash reserves include money in savings or held in accounts where making withdrawals is simple and quick. As a result, the value of investment portfolios typically doesn’t qualify. Stocks, bonds, and similar securities aren’t inherently liquid, so their value isn’t factored into the equation. Similarly, the value of other held real estate doesn’t count since selling takes time.

Proof of Income

Along with a liquid cash reserve, many hard money loan lenders require proof of income. The goal is to ensure that the borrower has a reasonable amount of cash coming in from a source other than the investment property they’re considering. That way, the buyer has a way to cover the hard money loan payments should the project head in an unexpectedly negative direction.

Beyond proof of income, the personal finances-related requirements are minimal, if not non-existent. While a hard money loan lender may run a borrower’s credit, there typically aren’t credit score minimums. As a result, any credit checks typically focus on factors other than credit score, such as a history of defaulting on similar loans.

However, some hard money loan lenders forgo traditional credit checks entirely. Instead, they concentrate on income levels, current property values, and after-repair values. The property is acting as collateral, so as long as it has enough value to cover the loan with room to spare, that may be enough in some cases.

Suitable After-Repair Value

When considering a hard money loan application, lenders compare the current value of the property to its potential after-repair value. The after-repair value is based on the project the buyer presents, allowing the lender to estimate how much the property will be worth based on the improvements, location, age, local market conditions, type of property, and similar factors.

Generally, the bigger the difference between the current value and after-repair value, the more attractive the loan is to the lender. Larger differences provide a sort of cushion, as project overages or standard shifts in the market likely won’t eliminate all profit potential.

In most cases, it’s the after-repair value that determines the maximum amount a lender is willing to offer. Additionally, as a result, it also influences the required down payment.

A Clear Project Plan

Assessing the after-repair value isn’t possible unless there’s a well-outlined plan in place for the project. Often, aspiring buyers need to thoroughly outline the bulk of the project, including building or renovation schematics, material and labor cost estimates, anticipated timelines, and similar details.

The more comprehensive the plan, the easier it to for the hard money loan lender to understand the buyer’s vision and goals. Plus, a formalized plan shows focus and dedication, which can play in a borrower’s favor.

Solid Investment History

While having prior property investment experience isn’t required by all hard money loan lenders, it’s a must for some. However, even if it isn’t an explicit requirement for a hard money loan through that individual or company, having a solid investment history works in a borrower’s favor.

For example, a borrower who’s about to undertake their first flip is viewed as riskier than one that has a dozen successful flips under their belt. As a result, the latter may qualify for lower down payments or more favorable terms. Additionally, their odds of approval are generally higher.

For those with previous experience, providing an outline of past projects is wise. This is particularly true if the borrower can demonstrate a clear history of finishing on time and under budget, as well as securing post-update sales at or above the anticipated after-repair value.

However, even if a borrower has no investment property experience, that doesn’t mean they won’t get approved. Instead, they may simply need to do more due diligence to demonstrate they have a solid plan and enough cash reserves to handle everything that’s involved. That strategy gives the lender more peace of mind, which may make them open to a higher degree of risk.

A Reputable Hard Money Loan Lender

Technically, finding a reputable lender isn’t a requirement for securing a hard money loan. However, it’s essential for borrowers who want to avoid predatory lenders.

Predatory lending takes many forms, but it all typically involves unfair loan terms designed to rob borrowers of equity or make seizing properties easier. Some consider all hard money loans inherently predatory, as they usually involve higher interest rates and challenging fee structures. However, that likely isn’t universally true.

Borrowers should perform some due diligence when considering lenders. Compare interest rates and fee structures. Examine the lender’s reputation. Speak with others who used the company for hard money loans. Also, make sure to read the entire loan agreement and have it reviewed by an attorney.

A Big Dose of Reality

While being realistic also isn’t an inherent requirement for getting a hard money loan, it’s nonetheless critical. The borrower needs to be honest with themselves about their financial situation and the viability of the project. It’s easy to underestimate repair costs, particularly since some issues aren’t always visible until work is underway. Having a sizeable financial cushion that can address overages created by unseen problems is, therefore, essential.

Additionally, getting accurate data about material and labor costs is a must. Being realistic about the timeline and potential shifts in the local market is similarly critical. Otherwise, even experienced property investors may end up over their heads.

Ultimately, it’s best to consider a big dose of reality to be one of the requirements for a hard money loan. That way, borrowers don’t move forward based on an overly optimistic perspective only to find themselves in trouble once the project is underway.

Do you think the requirements for a hard money loan make sense? Have you used a hard money loan previously and want to tell others about your experience? Do you think that hard money loans are too expensive to be wise options? Share your thoughts in the comments below.

Read More:

Originally Posted in The Free Financial Advisor

Sound investments
don't happen alone

Find your crew, build teams, compete in VS MODE, and identify investment trends in our evergrowing investment ecosystem. You aren't on an island anymore, and our community is here to help you make informed decisions in a complex world.

More Reads
Skyworks Solutions (SWKS) Stock: An Undervalued Chipmaker

Over the past five weeks, the market has been up 14.7%. Also, after the CPI report was issued last Thursday morning, the market and almost all the stocks had a tremendous run-up. In two days, the market is up nearly 7%.

2 Recession-Proof Utility Stocks With Safe Dividends

The Fed has raised the Fed Funds rate six times this year to combat inflation and the last four times at a 0.75% clip. The current 4% rate is the highest in well over a decade. But the Central Bank has indicated that it will take more pain to get that inflation genie back in the bottle.

WestRock (WRK) A Dividend Stock Comeback Story

Yes, this is a random WestRock (WRK) dividend stock, come back story. Why is it a comeback? WestRock decimated their dividend during the height of the pandemic from COVID-19. One of the world’s biggest, packaging companies reduced their dividend to $0.20 per share, per quarter from the high of $0.465.

AEP to Focus Capital Investments on Regulated Businesses, Reaffirms Operating Earnings Growth Rate of 6 to 7 Percent

Reaffirmed 2022 operating earnings guidance range of $4.97-$5.07 per share and midpoint of $5.02; 2023 operating earnings guidance range of $5.19 to $5.39 per share; Five-year, $40 billion capital plan emphasizes investment in wires and renewables

Southern Company - A Buy but Not Without Risks

We assess Southern Company to be a buying opportunity. For retail investors, this may be a good time to dollar-cost average into a position in SO.

Dividend Kings in Focus: V. F. Corporation

V.F. Corporation is a giant in the apparel industry. The company’s annual sales amount to nearly $12 billion, but the company has humble beginnings. It started all the way back in 1899 and has seen many twists and turns in the 123 years since.

October 2022 Passive Income Update – Lower Dividends, Higher Passive Income

The market decided to climb back up this month and then interest rates rose once again. The narrative hasn’t changed both Tiff and Powell have said they aren’t done raising interest rates in previous hikes. Unfortunately Tiff played his cards first hoping Powell would follow suit with a .5% raise and the US raised theirs .75% essentially devaluing our dollar. Inflation for Canadians should rise on this move alone as it now costs us more to buy stuff in usd.

Procter & Gamble Stock: Recession Resistant Dividend Aristocrat

When volatility grips the stock market, as it has this past year, income investors should focus on quality dividend growth stocks.

Dividend Income Summary: Lanny’s October 2022 Summary

This is what dividend investing is all about! Investing in dividend stocks allows YOU to earn dividend income, the best passive income stream! Bias, you better believe it.

10 Compelling ESG Stocks That Pay Dividends Now

In the world of investing, the goal is always to compound wealth as efficiently as possible. We think the best way to do that is to buy high-quality dividend stocks, reinvest the dividends, and stay the course over a number of years. However, investors can also infuse their own personal preferences or beliefs into their investing strategy, and still make great returns.

What are the Dividend Policies of the Top Utility Stocks

When an income investor researches utility stocks, the dividend policy is an important decision factor. Here are the dividend policies of the top utility stocks and what they say about the stock.

AMC Stock Forecast, Analysis, Price & News | Is AMC stock a buy

Based on the stock performance over the previous 8 years, AMC has traditionally increased by 80.5% during the following 52 weeks. Learn more!

Is Planet Fitness a Buy or Sell? PLNT target price

Based in Hampton, New Hampshire, Planet Fitness (NYSE:PLNT) is an American fitness facility franchisor and operator. Let's explore it!

Are we in an Index Fund Bubble?

Are we in an index fund bubble? Should you stay the course and keep investing, or should you sell and look for better opportunities? As with most things there is no one size fits all answer. The markets are in a state of turmoil, so it is easy to see why one would think that avoiding certain asset classes might be a good idea. Let’s take a look at index fund investing so you can see if it is right for you.

Dividend Stock Watch List: Lanny’s November 2022 Edition

Welcome back to another dividend stock watch list article! The stock market is still down almost 19% year-to-date, but the last full week of October there definitely was a big push!

Is Verizon a Good Dividend Stock?

Despite the recent uptick, the bear market is still growling in 2022. The Nasdaq and S&P 500 Index are down more than 20% each, while the Dow 30 is doing somewhat better. Consequently, many high-quality stocks’ stock prices have also declined, along with valuations. One such stock is Verizon Communications (VZ), trading near its 52-week low and the lowest price in a decade. But is the stock a value trap, or is Verizon a good dividend stock?

AWK Stock Forecast - Is American Water Works A Good Stock To Buy?

American Water Works (AWK) is a good stock to buy. Investors can take advantage of the lower price of this utility stock and get a stable dividend every quarter. AWK stock forecast is also positive.

Recent Stock Purchase October 2022

As you know by now I make a stock purchase every single month no matter what is going on in the world and despite the doom and gloom headlines. Perhaps I am naive or more of an optimist that we will get through these dark financial times somehow. Either way, I have been busy buying up some stock this month and was happy to put some fresh and recycled capital to work to try and recoup some of my lost dividend income courtesy of the numerous cuts bestowed upon my portfolio in recent years.

October 2022 Stock Considerations

A new trading month is about the begin and boy do we have a seemingly endless crop of stocks that are becoming fair valued to undervalued. The reality of the day is that we’ll continue to see stock prices continue to come down as interest rates rise. No reason to believe interest rates will stop climbing anytime soon.

5 Funeral Home Stocks and Death Care Trends

There are two certainties in life… death and taxes. Most people plan for taxes each year but few plan their funeral. It’s a tough topic to discuss but your family will be relieved that you had it planned. Losing a loved one is difficult and when you’re emotionally fragile and grief-stricken, planning a funeral is even harder. Funeral homes know this. They’re for-profit companies, and their industry is booming thanks to the world’s growing (and grieving) population.

Resources for Publishers
Resources for New Investors
Boosted with BossCoin
Financial Literacy Leaders
Tom Hamilton
Wise Intelligent
Mark Robertson
Kevin Matthews II
Akeiva Ellis
Brendan Dale
Kenneth Chavis IV
Sharita Humphrey