Real Angle: A Hard-Money Primer
Massachusetts real estate investors, including those in MetroWest, are enjoying an increasingly active housing market. Home buyers know they can be picky, so the nicest remodeled properties for the most reasonable prices tend to go first.
In this market, property rehabbers are looking for distressed or run-down properties in areas with a large pool of buyers to buy, renovate and flip for a profit.
But despite the evolution of the lending market over the years, there remain certain types of real estate which banks and mortgage companies simply will not finance, at least not without a substantial down payment. They include vacant rental housing, commercial properties and distressed single-family homes in poor condition.
For developers who think they've found a good deal on a property they wish to fix up and flip, but who don't have the capital to make it happen, there are few options for getting money.
Enter "hard-money" loans, which are based not on income or credit scores like a mortgage, but solely on the value of the property being lent against.
High rates necessitate speedy deals
Rehabbers use hard-money loans to purchase and renovate distressed properties.
Hard-money interest rates are typically in the double digits with several points paid in origination fees. The loans carry a much higher risk of default than a conventional residential mortgage, due mostly to the typical condition of the properties they're financing.
The goal is a quick turnaround, so that carrying costs such as interest, taxes and insurance don't eat up profits in the transaction. A typical property is purchased, renovated and resold to a homeowner in four to eight months. Hard money is also often used as a transition to more conventional financing.
Multi-family and commercial properties can be purchased with hard-money loans, and after renovation and stabilization, can be refinanced conventionally for a longer term.
Why would anyone pay those rates?
Speed and property condition are the two most common reasons a real estate investor uses hard money. In order for an investor to secure a favorable price on a property, an offer with a quick close will sometimes seal the deal. It's not uncommon for a hard-money lender to close a deal in two weeks or less. Conventional lenders will frown on loans paid off within six months because it affects their profit margins.
Perception and reform
Some people have a negative perception of hard-money loans, and in some cases it's deserved, but such lending can serve a real purpose in helping to revitalize neighborhoods.
And though certain unfair practices like large, upfront loan-evaluation fees and terms changing at the closing table persist in some lending operations, the industry has also gone through substantial reforms.
Prior to the passage of the SAFE Act in 2009, homeowners with poor credit scores, or those seeking foreclosure relief would look to hard-money lenders as the "lender of last resort."
That would sometimes result in the homeowner ending up in a worse position than before, because they could not afford the high rates. Stricter licensing requirements have all but eliminated residential hard-money loans, and now it is rare to find a private lender licensed to lend on owner-occupied properties. Most hard-money loans today are commercial loans.
Tips for using hard money (web only content)
If you're in the real estate business and looking for a reputable hard money lender, here are some tips: Ask other local investors, landlords, and bankers for references. Be sure to Google any lender before signing a deal. View any large, upfront fees with suspicion. Expect to put some of your cash down in the deal. And have a clearly-defined exit strategy that values speed in order to avoid high interest costs.
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