Many of the “real estate experts” stress the importance of using other people’s money (OPM). These “experts” say that it’s better to invest with other peoples money because then you get a greater return on your investment. In reality, if your investment really is great then you will be better off using your own money, but most of us don’t have hundreds of thousands of cash lying around. Anyways, that’s a different subject, this article is focused on the wisdom of using hard money.
Privately funded loans with high interest rates and fees intended for temporary financing are known as hard money loans. These loans aren’t called hard because they’re diffucult to get, what they are is hard to pay off. It’s not cheap to get hard money financing. They usually have high interest rates, about 10-18%, plus upfront fees from 3-5 points.
One of the major differences with hard money lending, and other types of financing is the criteria used to determine finance risk. The loan worthiness for traditional financing is determined by the borrower. The lender will only loan money if the borrower has a good credit score, a low debt to income ratio, and a consistent stream of income in which they will be able to pay for the debt. With hard money loans, the main focus is on the value of the property. When the value of the property is worth significantly more than the amount financed, hard money lenders will typically grant financing. If the borrower defaults, the hard money lender quickly forecloses and owns a property with substantially more equity than it was paid for.
Despite the risk, hard money loans can be very useful, especially for real estate investors. In order for many real estate deals to happen, the invester must have the financing within a few days. They must aquire loan money quickly. Good California hard money lenders are able to fund money in a very short period of time. If the property is a good investment, and there’s a solid exit strategy, then even though the borrowing cost may be high, the profit made is worth the cost. The important thing isn’t how much money the investor spent, but how much money the investor made.
Lets say a real estate investor borrowed $100,000 at 10% interest, flipped a property, and then sold it for $140,000 six months later. The upfront fee was $3,000, or 3 points. Their profit would have been three times greater than the hard money lenders..
Hard money loans can be a good tool for smart real estate investors, if they take caution and use them wisely.
