Here are the requirements for a hard money loan

conditions for a hard money loan

Hard money loans are one of the most popular options for buying homes for renovation and reselling them for a profit. Although there are alternatives – such as using a traditional or renovation mortgage – hard money loans generally fund much faster and are less restrictive. If you are considering a hard money loan for the purchase of an investment property, here is an overview of what hard money loans are and 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 are not available from traditional lenders like banks and credit unions. Instead, private companies or individuals can fund the loan.

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

The interest rate associated with a hard money loan is usually much higher than traditional loan alternatives. In addition, the repayment term is much shorter. While mortgages typically have repayment periods of 15 or 30 years, hard money loans may only allow a few years.

Since home turners typically aim to quickly renovate and resell an investment property, the shorter repayment tenure is not inherently problematic. As long as the investment property sells within the repayment period, the sale proceeds cover the cost of the hard money loan and any associated interest, and the investor keeps any remaining profits.

Hard money loans can also work for rental or commercial properties where anticipated income generation makes it plausible to repay the loan on time. In this scenario, investors can aim to complete any construction or renovations necessary to ensure that the property meets the livability or value requirements set forth by traditional lenders, giving them the option to refinance the hard money loan into a typical mortgage at the end.

Requirements for a hard money loan

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

Important down payment

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

However, the exact amount the lender needs as a down payment varies, especially depending on the borrower. If the borrower has a significant history of repaying hard money loans on time from their investment projects, the lender may require a smaller down payment compared to what they would expect from a less experienced investor.

The condition of the property being purchased is another factor that can affect down payment requirements. Additionally, the buyer’s plans for the property could also play a role. For return home, local market conditions may result in higher or lower deposits, for example.

Cash to cover fees and insurance

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

Liquid cash reserves

Most hard money loans are used to purchase properties that require renovations or land for the construction of a new structure. Since this is the case, buyers need cash reserves to successfully manage the project and meet all payment requirements for the hard money loan.

Typically, liquid cash reserves include money in savings or held in accounts where withdrawals are quick and easy. Therefore, the value of investment portfolios is generally not eligible. Stocks, bonds and similar securities are not inherently liquid, so their value is not factored into the equation. Similarly, the value of other real estate owned does not count because selling takes time.

proof of income

In addition to a liquid cash reserve, many hard money lenders require proof of income. The objective is to ensure that the borrower has a reasonable amount of cash available from a source other than the investment property they are considering. This way, the buyer has a way to cover loan repayments in cash if the project goes in an unexpected negative direction.

Beyond proof of income, personal finance requirements are minimal to non-existent. Although a hard money lender can manage a borrower’s credit, there is usually no minimum credit score. Therefore, any credit check typically focuses on factors other than credit rating, such as a history of defaulting on similar loans.

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

Value after appropriate repair

When reviewing an application for a hard money loan, lenders compare the current value of the property to its potential value after repair. The after repair value is based on the project presented by the buyer, which allows the lender to estimate the value of the property based on improvements, location, age, local market conditions, type of property and similar factors.

Generally, the greater the difference between the present value and the value after repair, the more attractive the loan is for the lender. Larger differences provide a kind of cushion, as project overruns or standard changes in the market are unlikely to eliminate all profit potential.

In most cases, the after repair value determines the maximum amount a lender is willing to offer. Moreover, it also influences the down payment required.

A clear project plan

Assessing post-repair value is not possible unless a well-defined plan is in place for the project. Often, potential buyers are required to outline the essentials of the project in detail, including construction or renovation drawings, material and labor cost estimates, expected timelines, and similar details.

The more comprehensive the plan, the easier it is for the hard money lender to understand the buyer’s vision and goals. Additionally, a formalized plan demonstrates focus and dedication, which can work in the borrower’s favor.

Solid investment track record

Although prior real estate investment experience is not required by all hard money lenders, it is a must for some. However, while this is not an explicit requirement for a hard money loan through this person or company, having a strong investment track record works in favor of the borrower.

For example, a borrower who is about to take their first flip is considered riskier than a borrower who has a dozen successful flips under their belt. As a result, the latter may benefit from lower initial payments or more favorable conditions. Also, their chances of approval are usually higher.

For those with previous experience, it is wise to provide insight into past projects. This is especially true if the borrower can demonstrate a clear history of finishing on time and under budget, as well as securing post-upgrade sales at or above expected post-repair value.

However, even if a borrower has no real estate investment experience, that does not mean they will not be approved. Instead, they may just need to do more due diligence to demonstrate that they have a solid plan and enough cash reserves to handle whatever is involved. This strategy gives the lender more peace of mind, which may expose them to a higher degree of risk.

A reputable lender

Technically, finding a reputable lender is not a requirement for getting a hard money loan. However, it is essential for borrowers who want to avoid predatory lenders.

Predatory lending takes many forms, but it typically involves unfair loan terms designed to deprive borrowers of equity or facilitate the foreclosure of property. Some consider all hard money loans to be inherently predatory, as they typically involve higher interest rates and difficult fee structures. However, this is probably not universally true.

Borrowers should exercise due diligence when considering lenders. Compare interest rates and fee structures. Examine the reputation of the lender. Speak with others who have used the business for hard money loans. Also, be sure to read the entire loan agreement and have it reviewed by a lawyer.

A big dose of reality

While being realistic is also not an inherent requirement for getting a hard money loan, it is nonetheless essential. The borrower must be honest with himself about his financial situation and the viability of the project. It’s easy to underestimate repair costs, especially since some problems aren’t always visible until the work is underway. It is therefore essential to have a significant financial cushion that can cope with the overruns created by invisible problems.

In addition, accurate data on material and labor costs is essential. It is also essential to be realistic about the timeline and potential changes in the local market. Otherwise, even experienced real estate investors could find themselves in over their heads.

In the end, it’s best to consider a large dose of reality as one of the requirements for a hard money loan. This way, borrowers don’t move forward with too optimistic an outlook only to find themselves in trouble once the project gets underway.

Do you think the requirements for a hard money loan make sense? Have you ever used a hard money loan and want to share your experience with others? Do you think hard money loans are too expensive to be smart options? Share your opinion in the comments below.

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