If you're a real estate investor looking for funding, you may have come across the term "hard money loans". These loans are typically used for short-term financing to purchase and renovate a property and are secured by the property being purchased. While hard money loans can be useful for some investors, there are both pros and cons to consider before deciding to use them.
We recently sat down with our friend, Josh Shein, to discuss the ins and outs of hard money lending, and how to get the most from a relationship with your hard money lender.
One of the primary benefits of hard money loans is that they are typically faster to obtain than traditional bank loans. This can be especially useful for real estate investors who need to move quickly on a deal to secure a property before someone else does. Hard money lenders typically look at the value of the property being purchased rather than the borrower's credit history, which means that investors with poor credit can still qualify for these loans. Another advantage of hard money loans is that they can be used to finance properties that may not be eligible for traditional financing. For example, if a property is in poor condition or requires significant repairs, a hard money loan may be the only option for financing the purchase.
The main downside of hard money loans is that they come with higher interest rates than traditional bank loans. This can be a significant expense for investors, especially if they need to hold onto the property for an extended period of time. In addition, hard money lenders may require a large down payment or charge high fees for the loan.
Despite the higher costs associated with hard money loans, they can actually increase an investor's return on investment (ROI) in certain situations. Here's an example:
Let's say an investor is interested in purchasing a fixer-upper property for $100,000. They estimate that it will cost $50,000 to renovate the property, for a total investment of $150,000. They plan to hold onto the property for one year and then sell it for $200,000.
If the investor were to purchase and rehab with cash, it would cost $150,000 out of pocket (plus property taxes and insurance). Assuming the property sells for the estimated $200,000 after one year, the investor's gross profit when buying with cash would be around $50,000 (not including taxes and other expenses), which would equal roughly a 33% return. However, if that same investor were to use a hard money loan with a 12% interest rate and a 12-month term, the monthly payment would be around $2,250. Because they would only need to make payments for twelve months, their total interest expense would be around $18,000. This would equal roughly a 277% return. Of course, there are closing and holding costs that need to be accounted for, but this example sheds light on how hard money leverage can be used to maximize returns. While the interest expense is higher, the investor is able to make a larger profit overall by using the hard money loan to quickly renovate and sell the property.
Hard money loans can be a useful tool for real estate investors, but it's important to carefully consider the pros and cons before deciding to use them. In certain situations, using a hard money loan can actually increase an investor's ROI, as demonstrated in the example above. However, investors should be prepared for higher interest rates and fees associated with these loans.
