Private Mortgage Equity
Most borrowers think private mortgages require equity in the property on which they are borrowing. This may or may not be true. Let’s do a quick review of what type of private mortgage equity is expected in a hard money loan.
A private mortgage from a non-bank private money lenders in Maryland is generally based on the asset you pledge as collateral. Most private lending companies or individuals want you to have at least 40% equity in the property (a 60% loan to value). The exact amount of equity varies by private lender and their investors, but it will likely be based on the amount and type of collateral as well as your personal financial situation.
For example, a private lender making a rehab loan or a bridge loan on a $100,000 residential property may require more than forty percent equity because the loan amount is so small. 40% of $100K is only $40K which isn’t much of a cushion if the project goes south. But 40% of a $1,000,000 commercial hard money rehab project, for example, is $400,000 equity which is a much more substantial equity safety net.
If you do not have equity in the project you are working on, many private lending groups will accept other collateral as a guarantee on the loan.
For example, you may own other real estate with substantial equity, or other assets that would satisfy the private investor. Many private lenders are lending their private investors’ savings. So think in terms of what you would want to satisfy you that the risk on a project is nominal.
Remember that obtaining a private mortgage is a loan, not an equity investment in your project. As such, a private lender is looking to minimize the risk of loss.
If you have a project with a high degree of risk with a high loan-to-value investment, you probably need to seek an equity partner and not a private lending group. Engaging with local real estate investing groups is a great way to find a potential partner.
The Buy Rehab And Rent Strategy
Investors have a number of ways to build their rental portfolio. One route is to purchase a turnkey property — one that’s filled with existing tenants, has documentation regarding income and expenses, and is ready to go. This can be a great scenario if the property is profitable (verification is of the utmost importance), but also understand that you pay top dollar. An owner will understandably expect to receive a premium price for a property that simply needs to be handed over.
With a little more work and creativity, you could instead look for the diamond in the rough and potentially land an amazing deal that results in monthly income as well as long-term profit. Consider a buy, rehab, and rent. As the name suggests, this is a property that will need work before it’s tenant-ready. The extent of the rehab is up to you; as when exploring rentals, be honest about your experience in rehabs when going this route. Rehabs can spiral fast if you don’t know what you’re doing.
Benefits of a buy rehab and rent strategy for building a rental portfolio:
- Lower purchase price. Any deficiencies should be reflected in the purchase price — and the more work, the bigger the discount. You will often find a lower cost of entry when you allow for a fixer-upper in your investment plans.
- Less Competition. Sometimes all it takes is stinky carpets to weed out the majority of the buying competition. Investors shouldn’t be put off by superficial issues, but with single families in particular, most buyers don’t know how — or simply don’t want to — look past issues that might look or smell gross but are easy to fix. In multi-families, a lot of investors seek the turnkey properties that come with a rent roll and solid bookkeeping. There’s less competition for the ones that need work and marketing before they’re ready.
- Refinance Options. If you buy at a discount and rehab properly, you should build equity in the property fairly quickly. This is a great benefit, as the option to refinance allows you to shop for your next rental a lot sooner than you might otherwise have. (You might have heard this referred to as the “BRRR” method — buy, rehab, rent, and refinance. Same principles!) In fact, hard money lenders in Maryland can help transition you from a hard money loan to a long-term loan. No need to juggle lenders.
Qualifying For A Hard Money Loan
You’ve found the perfect house to buy and flip. You’ve done your due-diligence, made your offer and got the property at a great price as long as you pay “cash” and close quickly, but you don’t quite have enough money on hand—now what?
Hard money loans help flippers in this exact situation. They are meant to aid flippers who need to close quickly and not jump through the hoops of a traditional bank loan. So, how can you get a hard money loan? First, you’ll need to make sure your team and your project qualifies.
Who Can Qualify for Hard Money Loans?
Unlike traditional bank loans, the primary factor hard money lenders are looking at is the overall profitability of the deal the investor is considering. Banks place tremendous focus on both the property as collateral and the buyer’s creditworthiness because they are lending as much as 97% of the property’s value. If the buyer fails to make their mortgage payments, the bank stands to lose money due to the high Loan-to-Value or LTV.
While a hard money lenders in Maryland wants to understand who they are lending to by reviewing the flipper’s experience, cash-on-hand, income and credit, their focus is more on the property itself. They will carefully review the value of the property, the extent of rehab that is planned for the home, and who the contractor is doing the work. As a result, hard money lenders will de-emphasize the credit and income profile of the borrower as a qualification for the loan.
Readmore Debunking 6 Hard Money Loan Myths
Debunking 6 Hard Money Loan Myths
True or false: the term “hard money loan” was coined because this type of loan is hard to get. The answer is: false. If a borrower has a good deal, the right documents in order, a well-prepared exit strategy, and enough cash to close, a hard money loan is relatively simple to obtain. In fact, the approval process for a hard money loan is much more flexible, and the lender can close much faster than a conventional bank loan.
Though many investors have realized the benefits of hard money lenders in Maryland
, this misconception—as well as many other age-old myths about hard money loans and lenders—are holding many potential real estate investors back from success. If you want to scale your real estate investing business, you need to leave the misconceptions behind.
Below we uncover the truth behind six common hard money loan myths:
#1 No Docs Needed
Myth: Documents do not matter to hard money lenders.
Fact: Though hard money lenders are more lenient than conventional lenders when it comes to documentation, the basics are still essential for a borrower’s loan qualification. Hard money lenders require documentation to evaluate the risk associated with the project and set loan terms accordingly, as well as to protect both themselves and the borrower from potential legal challenges.
One of the most important pieces of paperwork is the appraisal—the third party’s assessment of a property’s value and future potential. Other documents often include a title report, title insurance, a rehab budget for the property, and government-issued identification for the guarantors. The more well-prepared a borrower is, the faster the loan process becomes.
#2 Desperate Borrowers
Myth: Only desperate borrowers use hard money loans.
Fact: This is a misconception regarding hard money lenders’ flexibility. For the most part, hard money lenders will overlook certain shortcomings in a potential borrowers financial history or experience—for example: credit score.
However, many borrower’s often come to hard money lenders—like ABL—with a credit score that is considered bankable. Essentially, most potential borrowers are choosing a hard money loan over a conventional loan, not using it as a last resort. Borrowers decide to apply for a hard money loan for these two key benefits: the types of loans being offered (like rehab or construction), as well as the lenders’ closing speed and flexibility.
If a borrower does not want to pay the hard money interest rates for the benefit of doing more deals, they have a few options. First, they can pay a bank loan interest rate but have to deal with the lengthy closing time and stricter underwriting. They can also use their own cash, but will likely have to limit the number and size of their deals due to financial constraints. Or, a borrower may decide to use a partner and engage in a profit share – but this is almost always more expensive than the interest rate of a hard money loan. This is why a hard money lender is not usually a borrower’s last choice.
Smart investors tend to see leveraging hard money as one of the necessary tools to grow their investing business quickly and consistently.
#3 Too Risky
Myth: Hard money lenders are not as cautious as conventional lenders.
Fact: Since hard money lenders are often lending their own money to borrowers, they are less likely to approve truly risky deals that will leave themselves and the borrower with less than what they started with.
Plus, a good local hard money lender is situated where they lend. This means that they have advanced insight into their local markets, so they will know when a deal is too risky or just “risky enough.” For the most part, if you and your deal look promising on paper, a bank or conventional lender will quickly approve your loan—even if in reality the project is not set up for success. Hard money lenders take the time to evaluate your project and the property as best as they can to ensure your success.
#4 More Expensive
Myth: Hard money loans are more expensive than conventional loans.
Fact: Technically, hard money loans are more expensive than conventional loans because of their higher interest rates and other closing costs. But for most real estate investors, hard money loans are simply seen as the cost of doing business—paying for the cash (or tools) they need to buy and rehab their properties.
However, hard money loans may save you money in other ways. Remember: time is money. Hard money loans often have shorter terms, quick approvals, no prepayment penalties, and are flexible with borrowers’ timelines. Shorter loan terms also mean that you can pay off the loan faster and pay less lifetime interest.
Plus, many banks will only provide 50-65% of the total project costs, while hard money lenders usually offer 80-90%. So, you may end up paying more in total expenses, but you will be investing less of your own money into the project as a whole.
#5 Loan Sharks
Myth: Most hard money lenders are loan sharks.
Fact: False. This is somewhat of an outdated depiction of hard money lenders. Nowadays, there are billion dollar hard money lending companies that lend all over the country and are as legitimate as banks.
Most hard money lending companies—even small ones—are well-established and reputable. However, like any industry, there are the less reputable players so always be sure to do your homework before bringing on a new lending partner.
#6 No Exit Strategy
Myth: Hard money lenders do not care about a borrower’s exit strategy.
Fact: This misconception most likely stems from the far and few “loan to own” hard money lenders—ones all borrowers should avoid. These types of lenders seem to want your investment to fall through so they can take the property back at a discount.
However, a reputable hard money lender wants to hear a borrower’s exit strategy. This is because they do not want to end up owning a property and possibly having to go through the foreclosure process. Plus, they are putting a lot of their own time and money in to your project.
Having a strong exit strategy is part of proving your reliability to a lender. The most common exit strategies include: selling the rehabbed property, or refinancing into a longer term mortgage and holding the property for rental income. Your exit strategy must match your property as well as your own abilities and history. For example, if you happen to have a credit score in the lower 500s, refinancing your property is not the avenue for you—you will most likely not qualify for a bank loan. So figure out what fits best with your situation.
The Truth About Hard Money Loans
In recent years, hard money lenders have become a much more mainstream source of financing in the real estate world. Experienced and inexperienced investors alike are understanding the beneficial differences—whether it is speedy closings, flexibility, or inside knowledge—between hard money and conventional lenders that make hard money loans a better choice for their projects. Fortunately, myths that have always surrounded hard money loans are slowly being dismantled as more hard money lenders make a name for themselves and more investors turn to hard money lenders for the capital their business needs to succeed.
