The ongoing COVID-19 crisis has seemingly left a devastating effect on the global and U.S. economy. We must admit that prior to the downturn, we experienced a strong economic cycle. The sector that seen robust growth was in real estate. The retail market was thriving with new home buyers. Meanwhile, house flipping became popular and lucrative again, for both novice and seasoned investors. Yes, it is true traditional banks did facilitate and spur a good portion of this activity and growth. However, real estate investors often tapped into their toolkit and utilized hard money loans in the short- term to finance their project to completion.
During the last economic downturn known as, “The Great Recession”, traditional banks tightened lending requirements. Presently, we have found that this time is no different and banks have initiated some of these same practices regarding lending restrictions and requirements, despite current low-interest rates. The hard money loan alternative serves as a reminder that all is not lost in terms of real estate investors finance their projects. There are companies still providing such loans during these turbulent times. The following will highlight the characteristics of hard money loans in terms of who they benefit, the types, lending requirements, funds disbursed, and the importance of having an exit strategy during these times:
Who can benefit from a hard money loan?
These loans are essentially private loans provided to real estate investors, funded by private lenders. Investors benefit from this type of loan because the approval process and loan terms are conducive to real estate investor financing needs in the short term. These loans do not usually come with all the red tape involved with financing through a traditional government-regulated bank. The loan is typically backed by the asset that the investor is seeking to acquire, in terms of collateral.
Types of hard money loans:
1) Fix and Flip Financing – Typically carry a short term of 6-18 months where the borrower utilizes the funds for both the acquisition and rehab of their project or target property.
2) Bridge Loans – Also known as transactional funding, may be used to bridge the gap between the purchase of the investment property and long-term financing.
3) Construction Loan – Typically utilized for ground-up construction of investment properties.
Remember that the loan is backed by the investment property. Underwriting for a hard money loan is somewhat different. Are you buying the property at a discount? Have you determined the after- repair value properly in efforts to ensure there is enough cushion or profit to pay back the loan on time? Have you accurately gauged your estimate for renovations? These are all considered. While credit score is not paramount, it helps the lender determine the interest rate for the loan. In lieu of dealing with your traditional bank, borrowers will find interest rates to be about 4% to 10% higher than your traditional bank loan. Typically, a hard money loan can be approved and funded in 7-14 days.
Typically, the first disbursement is for the acquisition of the property. The portion of the loan allocated for the actual renovations is usually disbursed at predetermined project completion intervals and are referred to as draws, used to pay contractors, and acquire materials.
During these times it is important to be able to gauge your exit strategy when acquiring investment properties through these loans. Some things to be considered are whether the intention is to fix and flip the property or take the long-term approach to fix, refinance, and hold as a possible rental for years to come.