Hard Money and Private Money Lenders

What Exactly is a Hard Money Lender Anyway?

Private or "hard money" lenders are private individuals with surplus money available for investment. Some have deep pockets while some have limited resources. Based upon their own personal criteria, they lend this surplus money, primarily on a short-term basis, to real estate investors who use it for a variety of profitable purposes including buying and repairing distressed properties.

Why is it called "Hard Money"?

Don't be confused by the term "hard money." It doesn't mean that this money is difficult to find or obtain. Actually, it is some of the easiest money to procure. So why is it called "hard" money, you ask? Good question. In the world of finance, money is either "hard" or "soft."

Hard money has stricter terms and a clearly defined repayment schedule. Softer money has easier terms and a more flexible repayment schedule (e.g., debt service subject to available cash flow). In the case of private financing, the terms for hard money loans are exceptionally harsh with very low loan to values (LTV's), higher than market interest rates, and a lot of upfront points.

Typical Terms for Hard Money Loans

Terms for these types of loans will vary from lender to lender and will depend upon the experience level of an investor as well as the length of an investor's relationship with a particular lender. Generally, a hard money lender will provide a loan for 50-75% of the after-repaired value of a home at an interest rate of 12-18% for a period of 6 months to five years. They will also charge between 2-10 points as an upfront financing fee.

As you invest, you will discover that these terms will vary from lender to lender. Some will only charge interest while some will amortize their loans. Some will lend repair money; others won't. Some will place the repair money in escrow to be drawn out as the work is completed; others will let you leave the settlement table with it. Some will lend closing costs; some won't. Ultimately, when finding hard money lenders, you will need to determine their terms and how they might fit into your plans as a wholesaler.

Lending Criteria for Hard Money Lenders

Like terms, lending criteria also varies from lender to lender. Each has their own preferences with regard to areas in which they will and will not lend and types of investors to whom they will and will not lend. Some will check your credit, some will not. Some will do their own appraisals, some will not. Some will charge for an appraisal, others won't. Some will charge an inspection fee for each draw from the repair escrow, others won't. Some will only lend in certain areas while others will lend everywhere.

Some are more numbers-driven when it comes to decision-making while others go more on their feelings about you and/or the neighborhood. What about my credit? With terms so favorable to the lender, most hard money providers are concerned primarily with the value of the property, placing less emphasis, if any, on the credit of the payor. They just want to know that in the event the payor defaults they will possess an asset from which they can extract their original investment and possibly more. However, this is not to say that lenders desire to go through the hassle and expense of taking back and reselling a property but merely to point out that due to the terms of the loan, private lenders are secured, and feel secure, whether a borrower pays or not.

Hard Money Lenders Are People, Too

You must keep in mind that most hard money lenders are private individuals. They are not institutional investors who have a set standard of guidelines dictated by the federal reserves. They can be flexible, they can be tough. They are people just like you and I. You can talk to them. You can befriend them. You can laugh and joke with them. They can be your neighbor, your doctor, your attorney, or your bus driver. They usually don't advertise that they lend money, but instead are found through word of mouth.

A Great Resource

Hard money lenders are a great resource for real estate investors, particularly a beginner with limited resources (e.g. cash and credit). Having a hard money lender on your team enables you to confidently make offers on properties. It enables you to purchase properties when your offers get accepted, and it provides you with the funds necessary to do the repairs if needed. In fact, I have heard of some cases where individuals have even been able to borrow holding costs, but I have never met any lenders myself who will actually do this.

Finding hard money lenders isn't really a mystery. At least it isn't a hard mystery to solve. You just need to get out there and take the right steps toward uncovering them. There are many different ways their investors, attorneys, accountants, insurance agents, etc., who are generally to locate hard money lenders or private lenders. When talking with other professionals, I tend to refer to my lenders as "private lenders" simply because not everyone is familiar with the term "hard money lender." I have found most of my lenders by asking for referrals from others willing to help me because I do what I can to help them.

Some of my favorite people to ask are settlement/closing attorneys. They usually prepare the loan documents for hard money lenders and most attorneys will be able to give you at least one name. In fact, on a number of occasions the attorney whom I asked for a referral was a hard money lender themselves.

Accountants are also a good source for hard money lenders since they have clients who are sitting on a lot of cash and need to do something with it. In some cases, they even have clients who already hold paper. Such people are great to approach about lending money since they already understand the business of lending. They have either taken back paper upon selling a property or they have lent their own funds to someone.

Real estate paper is a very secure investment, and people who understand the business of lending don't mind doing real estate loans, especially when the LTV is low and the interest rate is high. If someone trusts their accountant enough to let them handle their finances, then a referral from an accountant should carry a lot of clout. Another method of finding hard money lenders is to write down the addresses of homes undergoing renovation.

With few exceptions, if I go to the courthouse with ten addresses to uncover the lender involved in each of these renovation projects, you will find that a private lender is funding at least one of them. Contact the lenders that you discover and get to know them, especially if they have already lent money on a home in an area where you want to invest.

Insurance agents who sell hazard insurance policies (particularly those that specialize with investment properties) have to put a "loss payee" on all of the policies where a lender is involved. The loss payee is the lender, so the insurance agent can tell who are private lenders and which ones are not. An active agent could probably go through their records and come up with dozens of names of people who have lent money privately on policies they have written.

Mortgage brokers can also be a good source for locating hard money lenders, particularly those that work with investors on a routine basis. I personally feel that any mortgage broker that deals with investors should have a hard money lender in their bag. If they don't, I wouldn't consider them a good mortgage broker. You may have to pay the mortgage broker a fee for the referral, but it is worth it if it means getting a deal done. Increasing your chances of finding a hard money lender has to do with the circles that you run in, the people whom you ask, and the number of people you ask.

Chances are if you are asking the cashier at your local convenience store if they know of any hard money lenders, the answer you get is going to be, "Huh?". If you ask an attorney or title company who works with a number of investors in your area, it is much more likely that you will find someone who will be able to provide you with the names of several lenders. If you don't get anywhere the first time, don't stop asking people until you find one.

Having a good hard money lender will help you to become more profitable. You will be able to take advantage of deals when they come available. You will be able to act quickly if need be. You will be able to obtain a prequalification letter from your lender to give yourself more credibility when making offers, and finally, you will be able to act as the bank by connecting your wholesale buyers with your lenders so they can borrow money to buy properties from you.

Pre-Qualification Letters

If you are pursuing a lot of properties listed with real estate agents you will need a prequalification letter to submit along with your offers on many distressed properties, particularly those that are owned by institutions. You can obtain a prequalification letter from a hard money lender for this purpose, and in fact, your offers will carry more weight when submitted with a prequalification letter from a lender that is active in your area whom most real estate agents - particularly the ones that specialize in foreclosures - will recognize.

Hard Money Lenders and Your Buyers,
A Match Made in Heaven

It is extremely helpful to have a stable of hard money lenders to call upon to finance the purchase and rehab of properties that you may want to buy. However, even if you never buy a property for yourself, the second and most important reason to develop contacts with as many hard money lenders as possible is that hard money lenders will be your best and most reliable resource in making sure that your deals are consummated when you sell homes to other investors. You want to become the bank.

Many prospective buyers for your wholesale properties are not all cash buyers, whether they claim to be or not. In reality, most cannot simply write a check from their bank account, but rather must borrow their money from other sources. Depending on their source of funds, this may or may not be OK. If an investor doesn't have a legitimate source of funds, then it is your job to screen them a little further to determine if they qualify for you to take them to one of your hard money lenders. Many are capable of making mortgage payments and completing a rehab and would love to buy your properties if they could come up with the cash.

In this case, it is your job to take control of the deal and lead them to the money. Become the bank as well as the provider of the property. But be careful. Maintain control of the transaction and use some discretion in deciding whom you take to your lenders. You don't want to burn bridges with your lenders by bringing them deadbeat buyers who default regularly. Your buyer's credit report should show an intent to repay all of their debts on time, and they should have some source of regular income which gives them the ability to make mortgage payments to your lender.

Ultimately, you want to be able to take anyone who wants to buy a home from you (assuming they meet your minimum criteria) to one of your lenders. I have developed a regular following of investors who buy from me because not only do I find the properties but I also line up the financing, and you can too.

Private Mortgage Loans Provide a Short-Term Financing Alternative

Private mortgage loans are made by private lenders instead of traditional financing sources such as banks, lending institutions, or government agencies. They usually are short-term (6 months to 3 years) hard money or asset-based loans, and the decision to lend is based on the equity and value of the property being put up as collateral, not on the borrower's credit.

These loans are a source of funding for professional real estate investors who wish to acquire, rehabilitate, or cash out equity of income producing property, and those who otherwise would not qualify for conventional financing. Private mortgages also assist real estate investors who need immediate financing without the financial documentation required by traditional institutional financiers.

Private mortgage loans are very secure because they represent a maximum of 65 percent to 70 percent of the appraised value of income producing property. On non-income producing property, a maximum of 55 percent loan to value is lent. Investors can expect to pay interest rates of 12 percent to 14 percent on first liens and 16 percent to 18 percent on second liens in this current low interest rate environment. Historically, first lien yield of six points over prime has been obtainable.

Why Borrow Private Money?

When interest rates of 14 percent to 18 percent are added to four to eight points, the borrower is paying more than 20 percent annually for a private mortgage loan. This is a good deal for private mortgage lenders, but why would borrowers want to pay these high rates when conventional mortgages range between 7 percent and 10 percent? Many reasons exist, but all fall into four categories.

Speed of Closing

Conventional mortgages usually take between 45 days and 90 days to fund, since institutional lenders need to obtain an appraisal of the property's value, perform a detailed examination of the borrower's credit history, and thoroughly evaluate the borrower's current financial status. On the other hand, private mortgage lenders usually can complete a transaction within seven to 10 days. Since the property itself is the main criteria used to determine loan eligibility, less information on the borrower is required, resulting in a much quicker approval process.

The private mortgage lender is protected by lending at a significantly lower LTV ratio: 65 percent vs. 80 percent to 90 percent for institutional lenders. Further, the private mortgage lender can make a decision within 24 hours of receiving information, whereas institutional mortgage money must be approved by a loan committee that may meet only twice a month.

Easy Application Process

While a borrower's lack of up-to-date personal financial information would negate or at least delay approval for an institutional mortgage, it should have no effect on the ability to obtain a private mortgage loan. Private mortgage lenders generally base their decisions on the asset used for collateral -- the property. If the property value is high enough and the income being generated from it is sufficient to pay the interest on the debt, the borrower's personal financial situation should not affect the private mortgage lender's decision.

Other Money Resources Are Not Available

A borrower may not qualify for an institutional mortgage loan for reasons ranging from low borrower credit scores or too much borrower debt. Further, the property itself may not support the type of loan the borrower wants: Many institutional lenders will not loan amounts under $500,000 and will not lend second lien money even if there is significant equity in the property.

In these cases private mortgage lenders may be the only available resource. Institutional lenders are concerned with both the appraised value of the property and borrower and property credit; however, private mortgage lenders are concerned only with the appraised value, as long as it represents a fair market price. Hence, if a property is producing or can produce sufficient income to pay the note and the value of the property will provide sufficient equity, the borrower's credit is not an issue for the private mortgage lender.

More Funds Available

Since private mortgage lenders base loans on the appraised value of the property, the borrower may be able to borrow more and therefore have less of its own capital invested in the property. In these instances, the borrower is not penalized for purchasing a property at a significant discount to market value.

Investment Parameters

The most important parameter private mortgage lenders consider when evaluating a loan request is LTV ratio. They typically will lend up to 50 percent on raw land or undeveloped property; 65 percent on commercial income producing property such as office buildings, shopping centers, and warehouses; and 70 percent on multifamily income property such as apartment complexes. The maximum amount usually will be lent if all criteria are met; lower amounts may be lent if the loan or borrower is considered less than ideal.

The second parameter is the type of properties to lend on, which often is determined by the ease in disposing of the property in case of default. Obviously, a single-use property that would take a year to sell is less desirable than a multi-tenant, income producing office building.

The third investment parameter is the cash flow or income potential of the property put up as collateral. Although many private mortgage lenders are liberal in this area, the monthly interest payments must come from somewhere. If the property is producing a cash flow after all expenses, the property income alone may cover the monthly payments without the borrower having to come out of pocket. This adds a great degree of safety to the note. Cash flow from other income properties also can substitute for cash flow from the property being placed as collateral.

The fourth major investment parameter the lender must consider is exit strategy, or how the borrower plans to repay the loan. Since most private mortgage loans are short-term, private mortgage lenders have a keen interest in analyzing whether a particular exit strategy is viable. For example, if the exit strategy is to refinance the property, the lender must determine if the credit score of the borrower is high enough to qualify for a long-term mortgage, if the property cash flow is sufficient to cover the debt payments, and if the property will meet the general criteria set up by the mortgage lenders most likely to refinance the property.

Dos and Don’ts When Working with Hard Money Lenders

Recent economic events internationally and on Wall Street have created a sudden shortage of capital to finance many worthwhile commercial real estate transactions. This has resulted in many borrowers seeking financing from lenders with privately raised and administered capital – sometimes called "hard-money lenders." These lenders fund a wide range of transactions – from local to national; loans from under a million dollars to under $100 million; construction loans to refinancing loans; and more. Most have one major theme in common – we are very busy (particularly lately). We need to review prospective projects quickly; and then speedily but carefully price, quote, finalize and close transactions.

The following are some do’s and don’t’s to think about as you undertake a loan with a hard-money lender.

DON’T send the lender an enormous pile of disorganized papers. Prepare a short deal synopsis, not more than two pages, which addresses the project and the loan requirements. Back this up with brief financial analyses, a map, photos, information on the borrower, and other supporting documents. Imagine a neat 6 page submission as compared to a 40 page disorganized pile of papers. Which do you think will receive the most attention the quickest?

DO describe the transaction: type of real estate project; location of real estate; type of loan; loan amount; equity available and source; term of loan; exit strategy; amount and types of debt that exist on the property; payoff situation; description of the borrower.

DON’T ignore or try to hide the "hair" on the deal. This will come out through the due diligence carried out by your lender, and will cast a negative shadow over the deal. If there is "hair" on the deal, a brief overview of the "story," or the events leading up to the story should be included.

DON’T tell the story of your life and the project’s entire life at the outset of your submission. Rather, start with the conclusion, the "therefore", (project, loan amount, purpose and term), and then support the "therefore" with the supplemental information you will provide. The details of the "story" will probably come out during a telephone conversation at a later date.

DON’T expect your lender to be willing to do your deal unless there is an exit strategy in place. You should identify the exit plan in your initial submission, and be prepared to defend the strategy. Two exit plans are better than one. Your lender is not likely to be interested in not being able to be repaid when your loan matures.

DO provide last year’s profit and loss statement showing NOI, as well as this year’s year-to-date profit and loss statement.

DON’T include mortgage interest and depreciation in the financial or P&L statements. Net operating income (NOI) before depreciation and debt service is what the lender will want to see. Don’t make your lender do the arithmetic.

DO show actual vacancy information clearly, as well as management fees, reserves for replacement, etc in the budgets. Assuming there will be no requirement for a management fee since the project is self managed is not useful. In the event of a default, the lender will most likely call in a professional management firm, and the cash flow must allow for this contingency.

DO provide a detailed rent roll, (and list each vacancy), list every tenant, lease term, rental rate, passthroughs, etc. Be sure that the numbers are all totaled and add correctly.

DO make certain that the total square feet of the rent roll is equal to the total square feet of the building; or the number of units and the number of tenants plus vacancies, are equal, etc.

DON’T send a complete appraisal report with the preliminary submission. Rather, copy and send the "Opinion of Value" or "Value Reconciliation" page, (be sure it includes the date) and perhaps the 2 or 3 pages of worksheets that explain how the value was determined. At this point in the deal evaluation, your lender has little interest in the neighborhood characteristics of the town or the largest employers where the property is situated!

DO include a page or two from the phase I environmental assessment (including the date), if available. The section showing "Conclusions" is sufficient, plus the cover page or letter of transmittal, showing the name of the firm that carried out the study and the date of the report.

DON’T hire an environmental assessment firm or an appraiser, if you don’t already have the reports on file. You will expect your lender to automatically accept your selected third party consultant. Routinely, the lender will prefer to engage one of their own selection, later, if they elect to pursue the deal.

DO send along a copy of the local town’s vote(s) on zoning, permits, and other approvals, only if a to-be-built or expansion project, as applicable. Don’t send the entire package of minutes; extract the vote and note clearly the purpose of the particular document.

DO include a few select color photographs. Obviously, a picture is worth many words, as well as a locator map, and 81/2 x 11 site plan.

DON’T send a full set of architectural and working drawings with your preliminary submission. What do you think your lender will do with another 5 pounds of paper?

DON’T send the lender originals. A busy, successful lender, (your preferred source of capital), probably receives dozens of deals every week. Keeping track of them is challenge enough, without being concerned about protecting your valuable originals. Also, returning them, if required, is time consuming and an unnecessary expense to your lender. Finally, you should be aware that it is your risk to send originals with your first submission.

DON’T package up a number of different properties into one deal analysis. Each property must be evaluated and stand alone. A consolidated financial analysis and spread sheet will not help the lender to identify and study each property separately. Even if the properties must be consolidated so that the "losing" property is supported by a "winner", each will require its own underwriting.

DON’T, at the outset, demand that the lender make a site visit. The lender’s time is of prime importance, and a site visit will not influence the lender to make a loan that is of little interest based on the documents. If the numbers and documents are a fit, the site visit will likely cement the deal, but not until then.

DON’T rely solely on your mortgage broker to make the deal. Shortly into the evaluation of the deal, the lender will probably want a direct conversation with the borrower. Offer a 3-way conference call including the lender, borrower and broker fairly early in the transaction based on your lender’s preference, to permit the lender and borrower to evaluate each other’s interest, style and objectives.

DON’T permit the mortgage broker to reply to questions directed by the lender to the borrower during telephone conference calls. The lender usually has a specific purpose in inquiring of the borrower, and is expecting the borrower to respond. Failure, or inability, to respond, is as powerful a reply as a timely and detailed response. The broker’s input is valuable when he/she is called upon during such a telephone call, and also to follow-up when appropriate, perhaps later, as the deal develops.

DON’T arrange to do a deal with a selected lender until you have completed your initial due diligence on the lender, including the lender’s interests, experience, qualifications, and references. If, after a week or two of negotiations, you then suddenly determine that you are uncomfortable with the selected hard money lender, you have wasted a great deal of time for each of you as well as your borrower, and the lender will not be pleased with this sudden revelation. If the lender resists providing evidence of their ability to make the loan being contemplated fairly early, move on to another who is more cooperative.

DON’T expect anyone to provide 100% financing.

DO expect to invest between 15% and 25% in cash (or legitimate equity in the property’s value if the property has already been acquired.) You have heard, often enough, that there are no more no-cash deals. DO rely on this rule, particularly in the recent economic climate.

DON’T expect the lender to accept the difference between the price you actually paid for a recent acquisition and the appraised value if higher, as your share of equity. From the lender’s perspective, the price you paid in an arms length transaction is the market value, You may believe that you "stole" the property for substantially less than the appraised value. Your lender will probably congratulate you for your accomplishment, but the purchase price will nevertheless be the demonstrated market value.

DO expect the lender to recognize an appraised value that is significantly higher than the price you have recently paid for a property, if, and only if, you have successfully completed a significant number of bureaucratic accomplishments since the purchase date (such as obtaining full entitlement), have newly negotiated signed leases, or have physically improved the property, and you can prove it.

DON’T expect your lender to lend you operating capital. One of the best ways to demonstrate your capabilities as a developer/operator is to invest your own capital into the project to underwrite start-up expenses. And what is the collateral for a business start-up? Unless your lender is also your business partner, why should you be loaned the start-up money for your own business?

DON’T expect your lender to rely solely on your enthusiasm for your deal as the only reason why your project will be a success. DO generate pre-leasing, pre-sales, or other demonstration of marketability. Market studies alone are seldom sufficient. Real prospects will ensure that your lender has serious interest in your project.

As lenders, we often hear, "When you visit the property and see the market, the project will sell itself." No it won’t. First the numbers have to work, then the due diligence has to confirm the numbers and the reports, and finally the chemistry between the lender and the borrower has to coincide. The site visit puts the entire project into perspective. Only then, has the loan a high probably of closing.