How To Become a Hard Money Lender
Hard money lending can be an excellent way for real estate investors to build wealth. If you have a high income, excess cash in the bank, and experience in real estate investing, you could offer investors private money loans. Becoming a hard money lender in real estate can provide high gains and fast returns. However, like most potential investments, they come with a high level of risk.
If you are serious about becoming a hard money lender offering hard money loans, there are several key factors to consider. After all, weighing the pros and cons of any investment is crucial to assess if it’s the right strategy for you. And learning about the intricacies of lending your money to other investors is vital.
This article explains what is involved with private money lending and will hopefully help you make an informed choice if this investment strategy is for you.
What Is a Hard Money Lender?
A hard money lender is a private lender who provides short-term, secured hard money loans to real estate investors. Also called private money lenders, they lend money with high interest rates, typically using the property as collateral. “Hard money financing” refers to the tangible asset used to back the loan’s value.
Unlike a conventional loan, securing a hard money loan involves a faster, less stringent approval process. Therefore, hard money loans are highly attractive to real estate investors, especially those who cannot get financing through traditional mortgage lenders like banks, mortgage brokers, or credit unions.
For example, hard money lenders may forego a credit history check and close the deal in a few days rather than a month or more. However, because greater risk is involved, hard money loan rates are higher than traditional loans. This fact makes hard money lending an attractive investment opportunity if you can provide loans.
Hard money lender vs. private money lender?
Technically, a hard money loan only uses the real estate as collateral. However, a private money lender analyzes the property’s value and the borrower’s financial status. Hard money loans are typically short term, whereas private loans have longer terms. This article uses the terms interchangeably.
How Does Hard Money Lending Work?
Private money lending involves a short-term, high-interest loan using equity or real property as collateral. Usually, lending private money to a real estate investor works this way:
- Loan origination: An investor finds a hard money lender and applies for a hard money loan. The lender conducts a quick property evaluation to assess risk and profitability.
- Property valuation: If the hard money lender thinks the property meets their lending criteria, they arrange a property appraisal to determine its current market value. They also calculate the after-repair value. If the property’s value exceeds the loan amount, the lender usually approves the hard money loan.
- Loan terms: The lender draws up a loan agreement. This specifies the loan term, interest rate, down payment, and repayment schedule. The borrower must provide necessary documentation, including property title, insurance, and other relevant documents.
When both parties are satisfied, they sign the hard money loan agreement, and the lender disburses the funds.
During the loan term, the lender may monitor the project’s progress. This usually happens in the case of a property rehab or development. Also, depending on the loan terms, the lender may require regular principal and interest payments. Or they may stipulate interest-only payments and a balloon payment at the end of the term.
How to Start a Hard Money Lending Business
Becoming a private lender can be an excellent way to generate passive income. If you take steps to mitigate potential risks, the rewards of lending hard money can be great.
So what does it take to get started as a successful hard money lender? Here are a few tips:
Set up your business
When lending private money to investors, setting up a business entity and structure is the first step. Most hard money lenders choose to establish an LLC (limited liability company). Additionally, some states require that private lenders obtain the right licenses and permits. Therefore, an attorney can help you know what federal and state laws apply to your situation.
Additionally, you may consider the following aspects when setting up your business:
- Get insurance to protect your finances.
- Decide if you want to attract other investors or use your own cash.
- Enlist the services of an attorney who specializes in lending money.
- Decide on a loan servicing strategy—will you do this yourself or enlist a third-party company?
The next step in becoming a hard money lender is to ensure you have enough capital. The cash available also determines the type of private investors you hope to attract. For example, many hard money lender rookies have limited cash reserves. Therefore, they may focus on finding fix-and-flip or rehab investors.
Sources of capital to become a private lender include the following:
- Large cash reserves in the bank
- High income and plenty of disposable income
- Retirement accounts or pension funds
- An unexpected windfall like inheriting money, real estate, or winning the lottery
- Getting other investors to join your business
Regardless of your funding source, you must have quick access to your cash, because hard money loans usually close quicker than traditional loans.
Finding clients can be challenging if you are new to private money lending. But all property investors need access to financing. Most seasoned investors prefer to avoid traditional lenders and use hard money loans to further their investment property business. Therefore, clients are out there—you only need to know where to look.
Successful hard money lenders know the importance of building a professional network. Some lenders start by helping a friend or family member buy a residential property. However, joining peer-to-peer lending platforms and connecting with real estate agents, accountants, and industry professionals is vital for building wealth and being a successful investor.
Also, don’t forget the power of marketing. Many commercial property developers and investors actively search for hard money lenders. Therefore, a good website, marketing strategy, and business model may attract new clients.
Types of investors who want to find hard money lenders include:
- Investors with high debt-to-income ratios
- Property investors who cannot get a loan from a traditional lender or bank
- Investment property developers who need fast access to funds
- Commercial property developers who need a bridge loan but cannot get one from a traditional bank
Sometimes, homeowners facing foreclosure may utilize hard money loans to avoid losing their homes.
Evaluate loan applications
Hard money lenders assess loan applications differently from traditional lenders. Rather than take the borrower’s credit history, debt-to-income ratio, and down payment into account, private loans are approved based on the property value. Therefore, due diligence on the investment property is crucial to minimize risks.
Here are key factors to consider when considering a loan approval:
- Property value: Ensure the property’s value and after-repair value exceed the loan’s value. A property appraisal is necessary to assess its value. At the same time, check the property’s title and necessary legal documents.
- Loan-to-value (LTV): The LTV is the loan amount divided by the property’s appraised value. Typically, hard money lenders expect an LTV of 50% to 70%, which is lower than a traditional loan.
- Borrower’s experience: Considering the investor’s experience is critical to minimize your investment risk. After all, private money loans can be highly risky investments. Depending on their experience, you may adjust the interest rate or other terms to minimize your financial risk.
- Credit history and financial analysis: While most hard money lenders prioritize collateral, many also conduct due diligence on the borrower’s financial status. For example, do they have a history of foreclosure or bankruptcy?
Remember that as a private lender, you are taking on a higher risk. Therefore, due diligence on the collateral is crucial. Because of the risks involved, borrowers expect to pay higher interest rates on short-term loans, make a higher down payment, and repay the loan in a shorter time frame than traditional loans.
Start lending money
Once you approve the private money loan, you can disburse the funds to the borrower. Usually, a short-term, hard money loan has a term of 12 months to three years. Therefore, you should see a faster return on investment than investing in the traditional real estate market.
Pros of Hard Money Lending
Hard money lending has many benefits if you mitigate the risk correctly. Here are some advantages you can enjoy as a private money lender:
- Invest in the real estate market without purchasing or managing property.
- Higher returns than fixed-income investments.
- There is always a demand for private loans in the real estate industry.
- Someone else is working hard to make your money work for you.
- You retain control over the terms of the loan and who you approve.
- Successful hard money lenders enjoy returns between 8% and 15%.
- In many states, you can loan hard money without a license.
- Offer flexible loan terms to private investors.
- You can charge higher interest rates than traditional loan providers.
Cons of Hard Money Lending
Hard money lending also has its drawbacks. For example, you must have enough capital to get started, and your investment is at greater risk. After all, some investors seek loans from private lenders because they have been refused a traditional mortgage.
Here are some considerations about becoming a private loan provider:
- Hard money loans are more suited to wealthy investors.
- They are a higher risk for lenders than traditional mortgages because you rely on collateral, not the borrower’s financial health.
- Property depreciation can impact investments.
- You must develop criteria for what constitutes a risky real estate investment.
- It’s easy to overlook important factors during due diligence.
- Being a hard money lender without a loan originator and loan servicer can put more of your investment at risk.
Alternatives to Hard Money Lending
What are alternatives to hard money loans if you want to invest in real estate without purchasing property? Several options exist to get involved in real estate lending without becoming a hard money lender. Here are a few options:
- Real estate investment trusts (REITs): You can invest cash in publicly listed companies called REITs that own, operate, or finance investment properties.
- Real estate crowdfunding: Investing in crowdfunding platforms gives you options to diversify your portfolio and invest in high-value real estate. Additionally, you can invest in other parts of the country where the market is healthier.
- Partner with other investors: Joining a real estate syndicate is a great alternative to hard money lending. You can invest passively and enjoy a nice return on your investment.
Hard Money Lending: A Takeaway
A hard money loan is an alternative financing model that many investors use. Unlike a traditional loan, the approval process is faster, and the criteria are more flexible. For private lenders, a hard money loan can be a lucrative investment that generates regular income and boosts capital reserves. In many cases, hard money loans are a win-win situation for lenders and borrowers to build wealth.
However, before lending your own money to property developers or investors, it’s vital to consider the pros and cons of providing hard money loans to make smart personal finance decisions.
Hard Money Lending FAQs
Here are some questions many investors ask when considering becoming a hard money loan provider.
How much money do you need to start a lending company?
It can cost between $5,000 and $10,000 to become the business owner of a hard money lending company. However, this doesn’t take into consideration additional business costs like setting up a website, developing a marketing strategy, and printing business cards. However, the largest cost is typically attorney fees.
What are the licensing requirements for hard money lenders?
Licensing requirements to provide hard money loans depend on the state. Some states require private lenders to obtain a license. In contrast, others stipulate they must have a real estate broker or mortgage license. Therefore, it’s vital to check with your local department of real estate to learn which laws apply to your situation.
Additionally, you must comply with your state’s usury and banking laws regulating the interest level you can charge.
Is hard money lending a good investment?
Becoming a hard money lender can be a lucrative investment. You can enjoy high returns on investments more quickly than with traditional real estate investing. Typically, real estate appreciation is more stable than investing in stocks, and interest rates are better than savings accounts.
How do hard money lenders generate income?
Typical yields on hard money loans are between 8% and 15%. However, apart from earning money by charging interest, hard money lenders have additional ways to increase their return on investment. Here are a few ways:
- Joint ventures: You could negotiate to receive a percentage of the profits in exchange for lower interest rates or require less money upfront.
- Points: Some borrowers pay points in exchange for a lower rate of interest. One point equals 1% of the loan and is usually paid at the start of the loan.
- Exit fees: The borrower pays a predetermined amount at the end of the loan. The fees could be a percentage of the loan amount. Or you could increase the exit fee if the borrower requires more time to repay the loan.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.