How to Qualify for a Hard Money Loan
Hard money financing comes in handy when you have a real estate project for which you lack the money to finance. The typical sources of financing for real estate investors are traditional banks and mortgage lenders. But when you need money quickly or you have a low credit score, the usual lenders may become a bit tight fisted. In this case, hard money or private money financing is your savior.
Though private money loans come with substantially higher interest rates (between 10-16%) and short repayment periods (1-2 years), many real estate investors find them highly favorable. If you need a hard money loan, here are the most common requirements you need to fulfill in order to qualify. Please note that these are only general requirements, specifics may vary from one lender to the other.
1. Good credit rating
A low credit rating is not an automatic disqualification for a hard money loan. It is still possible to find a private lender willing to loan you with a low credit score as long as there is collateral. But to increase your chances of getting a loan and to receive favorable terms, it would be better if your credit score is good. If you are planning to look for a hard money loan in the future, consider working towards a better credit.
This is an absolutely necessary requirement for a private money loan. Most financiers will take the property you want to buy as collateral. This protects their investment and ensures that they get their money back in the event of a default.
In some cases, especially if you lack adequate down payment, the lender may require a cross collateral. This is where they use another property you own, and which has some equity, as a second collateral.
3. First lien
Typically, hard money lenders do not give loans for second mortgages. This is meant to protect them if you default. In that event, they are the first in line to receive proceeds from the sale of your property. So you should only consider going to a private money lender only if you need a first mortgage.
4. 60-70% loan to value ratio
A loan to value ratio compares the after repair value (ARV) of a home to the loan you are getting. Take for example the value of a property after it has been bought and all repairs done to be $100,000. If you got a loan of $60,000 to finance the purchase and renovation, then the loan to value ratio is 60%.
Most hard money investors will only agree to a ratio of between 60 to 70%. This ensures that even if you default on the loan, they can still make a good profit if they sold the renovated house.
Since the ARV has to be determined before even purchasing a property, a lot of research and valuation has to be carried out by both parties. This involves comparisons with similar properties in the area, consideration of the prevailing market prices for similar real estate and the use of professional valuers.
5. 30-40% down payment
Another form of protection that hard money lenders take is requiring a certain amount of down payment from you. This gives them the assurance that you also have a lot of money to lose and therefore will take all measures to make a profit. Once you calculate the purchase cost of the house and add it to the estimated repair cost, 30-40% of this sum is what will be required as down payment.
6. Clear exit strategy
As mentioned, repayment periods for hard loans are often very short, around 1-2 years. This means that you, the borrower, needs to convince the lender that you have a clear strategy to pay back all the money (principle plus interest) within the agreed amount of time. This is referred to as the exit strategy. It can involve making one huge payment after the sale of the house or looking for alternative financing later on when the property is now attractive to traditional lenders.
Hard money loans have many benefits over traditional loans. They provide a way for real estate investors to invest quickly without all the red tape involved with banks. But get ready to do all the hard work of convincing the lender that you deserve the loan.