A good lender is one of the greatest resources a real estate investor can have. Some deals, however, don't fit the criteria for traditional lenders. This doesn't mean you can't finance the property; it just means you might have to find alternative types of loans.
Here you'll get an in-depth explanation of hard money loans before getting to the list of the best hard money lenders. You should have a thorough understanding of what hard money loans are and what they're used for before committing to this financing option for your real estate purchase.
What is a hard money loan?
A hard money loan is a type of real estate loan issued by a private lender for non-owner occupied property. Hard money loans are usually short term, between six and 36 months, and have a higher interest rate than traditional bank loans.
Hard money loans are approved based on the value of the real estate more than the creditworthiness of the borrower. These loans are often used because they have an exceptionally fast approval time. Hard money loans are often closed within two to four weeks.
How are hard money loans different from bank loans?
The main difference between a hard money loan and a typical bank loan is the lender itself. Hard money loans are almost always given by a private lender, whether that's an individual or a private lending company.
Since these loans are used for non-owner occupied real estate, they aren't regulated like consumer mortgages. This means hard money lenders can charge higher interest rates and fees and get away with terms that wouldn't be allowed with traditional loans.
Even though the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA) don't typically apply to commercial mortgages, there are still regulations that traditional financial institutions have to follow. Federally insured banks are still regulated by the Federal Deposit Insurance Corporation (FDIC) and credit unions by the National Credit Union Administration (NCUA). Hard money lenders don't have any regulations placed on them.
What types of real estate do hard money lenders finance?
While a hard money lender may loan on any type of non-owner occupied real estate, they're usually looking for situations with a fairly quick exit strategy so they know they'll get paid by the end of the loan term.
Hard money loans are very common with fix-and-flip properties. In fact, many lenders will even finance the repairs. These types of deals are ideal for the lender since flips are usually completed within six months.
If the lender is also financing the repairs, they will estimate the cost of the repairs and issue draws as the borrower needs them to pay for the work being done. This ensures that the funds are being used for the repairs and limits the lender's exposure since they're only giving out portions at a time.
Many hard money lenders even prefer to finance the repairs so they know that the project will be completed. If the borrower gets through the demolition and runs out of money, the value may become less than the purchase price. By financing the project, they don't have to worry about the borrower not being able to finish the job because of a lack of funds.
Hard money lenders will also provide short-term loans for residential real estate investment properties. The goal here is usually to refinance the property in 12 to 36 months to be able to pay off the hard money loan.
Investors may turn to a hard money loan for a rental property if they need to be able to close the deal quickly and don't have the time to go to a bank. They may also need a private loan if the rental property needs repairs before a bank will finance the deal.
Similar to loans for rental properties, investors may need capital quickly to close on a multifamily property when there's not enough time to go through the traditional lending process.
An investor may also be buying a multifamily property with little to no tenants that's in need of a lot of repairs. This type of property would be hard to get financed with a bank, so they may seek out a hard money loan. They can get the necessary work done and lease up the property before refinancing it with a long-term loan.
Commercial real estate
A common situation with commercial real estate is an investor having a tenant to lease space to but no property to put them in. The investor will find a vacant property that the tenant will lease out, but they have to purchase the property and get it ready for the tenant first.
A bank may not want to finance a vacant property intended for use as an investment if the borrower doesn't have the assets to secure the loan. A hard money loan can be useful in this situation to get the deal done, do the tenant improvements, and get it leased. Once the tenant is in place and paying rent, a bank will be more willing to finance the real estate.
Interest and fees on a hard money loan
The convenience and easy approval with a hard money loan comes at a cost. Lenders will charge higher interest on hard money loans because they're higher-risk loans and because they're short-term.
Longer-term loans will earn interest for several years from processing one loan. The money invested in hard money loans has to be reinvested every six to 36 months. There's additional cost and new risks every time that money is invested in a loan.
Interest rates from private lenders start out at around 7% for lower-risk deals, but interest rates or these loans are more commonly around 10% and can go as high as 13% or more.
There are also upfront fees that the lender will charge to cover the cost of processing the loan and any commissions being paid. This also ensures they still earn a profit if the borrower pays off the loan before the end of the term.
Common fees for a hard money loan include:
- Origination fee: Usually 1% to 3%.
- Broker fee.
- Application fee.
- Underwriting fee.
- Doc prep fee.
- Processing fee.
- Funding fee.
These fees can add up to $3,000 to $5,000, not including the origination fee, and are often paid upfront.
Loan approval guidelines
Hard money lenders don't normally follow the same underwriting procedures as banks. They don't pick apart the borrower's finances like a bank does, in most cases. They also aren't usually as concerned with where the down payment funds came from.
The lender will probably do a credit check, but they are usually only looking for a minimum credit score of 600 to 620. They mainly want to make sure the borrower hasn't defaulted on several loans or isn't drowning in debt.
The main concern in the underwriting process is the value of the property and the market it's in. Hard money loans are a higher risk for the lender, so they want to make sure they are going to be able to get their money back if they have to foreclose.
There's usually an appraisal to verify the property value, but the lender also wants to make sure that similar houses are selling in a reasonable amount of time in that market. They don't want to be sitting on a house for several months waiting for it to sell.
The lender has to consider the borrower's exit strategy, since this is how they are going to pay off the loan. There is a balloon payment at the end of the short term, so they want to be confident that the borrower can pay it.
If the borrower is planning on flipping the property by renovating it and selling it at a profit, the lender knows they'll get paid at the closing table once the borrower sells.
If the borrower intends to refinance the property by the end of the term, the lender will want to be confident that they will be able to get financed. The lender may not be as willing to lend to someone with bad credit. They will look closer at the borrower's credit and personal finances in this case. They may also require a higher down payment to limit their risk in case the borrower can't pay the lender off at the end of the term.
Some hard money lenders also offer long-term financing on investment properties with five- or 10-year terms. They may be willing to do the refinancing in-house if the borrower meets the credit requirements.
The lender might also go into the loan with the intention of renewing the hard money loan if the borrower can't get refinanced in time. This isn't a terrible situation for the lender because they will continue to get the high interest rate for another term.
Hard money lenders also consider the borrower's experience. If they're lending on a fix-and-flip property, they like seeing borrowers who have completed at least a couple of other deals.
Smaller lenders usually stick to markets they know and states that have a strong real estate market. Most of them don't like properties in rural areas. If they do lend in rural areas, they will probably only approve the loan with a lower loan-to-value ratio (LTV). Something like 50% to 60% is common in rural areas.
Loan funding timeline
The appeal of hard money is the short amount of time it takes to fund the loan. Since the underwriting process is mainly focused on the property value, loans will be approved within 48 hours in many cases.
A lot of private lenders are made up of a small group of investors and have a limited pool of money available. Commonly, the loan officer or underwriter will have to get approval from the investors once the underwriting is done.
Hard money lenders don't have customer deposits to fund loans, and they can't borrow money from the Federal Reserve. They're limited to their own funds from private investors, so they have to set money aside for each approved loan. Otherwise, they might not have quick access to money when it comes time to close.
Once the loan is approved, the lender orders an appraisal. The loan can usually be closed within a couple of days of the appraisal being completed.
If everything is moving quickly, and there aren't any unexpected delays, a hard money loan can be funded in as soon as seven to 10 days, depending on how long the appraisal takes. That's extremely fast compared to a conventional bank loan.
Some hard money loans are even financed through crowdfunding now. The crowdfunding platform underwrites the loan, orders an appraisal, scores it, and sets an interest rate. Then they put it out on the platform for individual investors to fund portions of. Funding on this type of loan may take longer, depending on how long it takes to get enough investors to back it.
Hard money lenders for first-time investors
First-time investors can have more trouble getting a lender to fund a deal. This is especially true with fix-and-flip loans. The lender has no way to know whether the borrower is capable of managing the construction, or managing tenants, in the case of an income property.
Some private lenders only work with experienced investors. They require a borrower to have a minimum amount of successful deals under their belt to get approved for a loan. They'll usually require some sort of verification of the previous investments.
For a flip, they may want to see the closing documents from the initial purchase and the sale. For an income property, they would probably look at proof that the borrower owns the property as well as recent income statements or tax returns.
Hard money loan risks
The lender isn't the only one taking a risk on hard money loans. The high cost of borrowing hard money can make them difficult to pay back if the property being purchased isn't as profitable as anticipated. This could result in the borrower losing the property after investing all of their money in it or going completely broke to pay it off.
There's also the risk of working with a dishonest lender. Some lenders may use "bait and switch" tactics. This means they will offer great terms and a low interest rate in the beginning, then change the terms later on. They may even change the terms at the very last minute, leaving the borrower with no choice but to accept the new terms or lose the deal.
This is why real estate investors should only work with lenders that have a good reputation and have all of the loan documents and agreements reviewed. Some loan agreements may commit the borrower but let the lender change terms or back out of the deal at any time.
Anabel Uribe, a loan office with Investor Property Loan, offers real estate investors some advice for talking to hard money lenders. "Sometimes it can be very obvious if you're talking to a dishonest lender. When someone pitches a rate and term to hook you without scrutinizing the deal to some degree, that's usually a bad sign. If a lender is asking you a long list of precise questions before giving you a quote (in-person or over the phone), then you're most likely talking to a pro."
Uribe also provided a list of questions a real estate investor should ask a lender:
- How long have you been in business?
- What kind of deals do you finance most often?
- What is a conservative turnaround time to close?
- Are there any other "junk" fees outside of points, processing, and underwriting that are associated with this loan?
- Are the fees paid upfront or rolled into the loan?
- If the fees can be paid upfront, is there room to negotiate a lower interest rate?
You may also want to consider using a loan broker to source your hard money loan. Reputable brokers spend a lot of time building relationships with direct lenders. They have also worked with enough of them to know who to trust.
A broker can also connect you with the right lender based on the type of property, the loan amount, your experience, and the market you're in. You'll likely get better loan terms working with a lender that is comfortable with your type of deal.
Brokers can be helpful in preparing the necessary information to send to the lender. Having the right documentation to send to the lender right away can help you get approved and speed up the process.
Using a broker can come at a cost, though. Some lenders may lower the origination fee when a broker is involved so the broker can charge their own fee. A broker's fee can range from 1% to 4%, depending on the deal size. The fee is usually on the lower end with larger loans.
However, if a broker can get you a lower interest rate, it could be a good investment.
Five best hard money lenders
These hard money lenders have the best reputations in the industry. They have fair terms compared to other lenders in the industry and have proven to be able to close deals quickly without changing their terms last minute.
The top five hard money lenders in the industry are:
- RCN Capital.
- Lima One Capital.
Review the loan amounts, interest rates, terms, minimum credit scores, and time to close for our five best hard money lenders.
RCN Capital is a nationwide lender that offers hard money loans for fix-and-flips, rental properties, and multifamily properties. They also do long-term rental financing, which hard money borrowers may be able to qualify for at the end of their loan term.