Hard money loans can be a great financing method for real estate investors to get the funds they need fast. But they come with their own risks. Here are some good, bad, and ugly scenarios that can occur with hard money loans.
NOTE: If you’re looking for a hard money loan for a potential real estate project check out our Hard Money Lenders Directory for 50 States.
Hard Money Loans – The Good
The Hard Money Loan is Approved, Even With Bad Borrower Credit
A borrower with bad credit can still get a hard money loan to flip a house or renovate a property to increase its value. In fact, most hard money lenders will look past a bad credit score if they have confidence the borrower can complete the rehab and make money on the property. There are some exceptions to this, largely dependent on the type of bad credit events in the borrower’s history.
The Lender Approves the Loan Fast
Hard money loans can be approved fast, generally in less than 7 days, and as little as 24-48 hours. This allows the flipper to move quickly and get the rehab started on the property without delay.
If there are issues getting the documents and financials finished, getting a hard money loan could take longer than a week.
In comparison, using a conventional bank loan would take much longer, upwards of 30 days.
The Lender Sticks to the Deal
A good lender will provide the promised funds, stick to the agreed interest rates, and not drop unexpected fees and funding delays. If you select the right lender from the outset and stick to your end of the deal, you will not face any of these issues.
The First Lender a Borrower Approaches Works Out Well
This can happen if a borrower uses the advice and assistance from other real estate investors and flippers in their network. If the first lender offers good terms, has well-oiled processes and funds the loan without issues, this is a good sign your property deal is a good one.
If you’re new to using hard money loans to finance your real estate projects you should remain cautious on committing to a hard money lender. It’s important that borrowers do their due diligence and speak with multiple lenders to minimize potential risk.
Contractors Get the Job Done
Hiring only good contractors means your project will be done to code without delays or cost overruns. This includes subcontractors that work on the project, such as electricians, plumbers, roofers, etc.
This is perhaps the most important component of a real estate project funded with hard money. A reliable, high quality contractor can make the difference between success and failure.
Real Estate Market Conditions Remain Strong
The best time to flip a house is when the real estate market conditions are strong or starting to boom. If this is the case, then the profit margin on the flip can exceed initial expectations.
Market timing is key when using hard money loans to flip real estate. Even a quick flip will take 30–90 days to fix up, 30–60 days on the market, and then another 30–60 days to close. This means flippers should expect at minimum of 3 months if everything goes quickly, and 6 months if things take a bit longer.
A hard money lender will know the real estate market conditions and may loan higher than 70% LTV ratio if they expect the value of the property to go up significantly in the short term.
An Accurate Appraisal Was Done
A good appraisal will spot all the major structural issues on a property. Ideally you want no major surprises to be uncovered later during the rehab work. These include major plumbing, support structure problems, or termites.
The fact is, the appraisal can make or break a house flip when using a hard money loan. If the appraiser misses something, it could spell disaster for your flip. This is why hard money lenders require appraisals done on the property and will even provide their own.
The Borrower and Hard Money Lender Form a Successful Long Term Relationship
Hard Money lenders favor experienced flippers and rehabbers over rookies. If they have worked with a successful flipper before, they will most likely grant them favorable terms and better rates, along with shorter approval times.
Hard money lenders want to form long term successful collaborations with real estate investors. When a solid repeat relationship develops it’s a win-win for both sides.
Profit Margin On the Deal Is High
Profit margins on hard money funded real estate deals can be significantly higher than many other types of investments. These can range from 15% and higher and up to potentially greater than 50%. Much of this depends on the market conditions, the experience level of the borrower and lender, and how well their respective teams got the job done.
The Property Is Ideal For Flipping
When an investor purchases a property that meets the ideal conditions for a flip, it can mean big profits.
These include mostly cosmetic improvements with only minor structural repairs. Also, the neighborhood should be experiencing improvements and increased property values. The local economy should be strong or transitioning from a weak state to stronger condition.
Hard Money Loans – The Bad
Contractors Do a Poor Job
This is a bad one indeed. Contractors doing a poor job can cause delays and cost overruns. Worse, it could lead to liens on the property, or foreclosure if you run out of money before paying off the hard money loan. Always make sure to only hire the best licensed contractors you can afford.
The Loan Deal Blows Up
This happens when a real estate investor goes to a hard money lender who agrees to the deal, only to renege on it after the flipper has got the rehab team set in motion.
There are a number of reasons for this, including the lender discovering a red flag in the borrowers past credit history, or the lender is a shark and tries to foreclose so he/she can take the property.
In these cases the borrower has to find another lender fast, which means they are losing time and money. Market conditions can change at any point, so this kind of delay can mean lost profits and significant headaches.
The Property Does Not Sell Fast Enough
The market may not support finding a buyer quickly, leaving the borrower-investor holding the property longer than expected.
Depending on the market, a good hard money lender may be able to help find a buyer for the property — for a cost of course! Using a good real estate agent, or connections in your network can also mitigate this risk.
Large Unexpected Costs Show Up
Large unexpected costs can doom a real estate project and kill any potential profits.
For example, septic and sewage problems can be a major issue, made potentially worse by having to comply with city standards. This means custom repairs must be made to connect with city sewage infrastructure.
Also, buying a property with an addition that was built without a permit can cause serious problems. A building inspector can spot this and it could mean the whole addition needs to be torn down. This can happen if the addition was done without proper construction methods and the contractors cut corners.
Avoiding unexpected costs requires a good, thorough inspection of the property before the investor commits to buying it. If not, hefty structural issues could eat up all the profits, or even lead to a total loss.
You Chose the Wrong Property
Choosing the wrong property can mean a longer and more expensive rehab, and a difficult selling process.
A good hard money lender will likely deny the loan at the beginning if they suspect the property is too risky.
A flipper should always value properties by calculating the After Repair Value (ARV) and using appraisal best practices. This emphasizes the need to do a proper house flipping cost analysis on the project beforehand.
Interest Rate and Fees Are Too High
If loan interest rate and fees are set too high, the borrower could end up scrambling to pay them.
If the borrower does not pay the higher interest, they may lose their property to the lender. This can happen if unexpected rehab costs or lien appear, causing the borrower to delay or miss payment, and having the interest rate and fees escalate quickly.
Normal hard money interest rates are between 8-12%, but can go as high as 15-18% for inexperienced flippers or risky projects. It is best for flippers to seek a hard money loan when the market is strong. If this is the case, a hard money lender may go as low as 7%.
Problems With Online Hard Money Lenders
Online hard money lenders provide convenience to borrowers, but there are risks involved.
The first risk is the lender not being local, and therefore not having a complete understanding of the deal they’re financing. A hard money lender with local market knowledge is an invaluable partner because they will not loan money on very risky projects with a low probability of success. This is a second set of eyes to help the borrower stay out of trouble.
Another risk is misunderstandings or incomplete documentation leading to loan denial. Submitting documents online and hoping for the best does not give the opportunity to discuss the deal and strategy with the lender.
Finally, online lenders are more likely to involve payment issues than local lenders. As a borrower, you can’t simply walk down to the office with a check or cash and make a payment. This means there are more opportunities for payment delays or money transfer issues that can lead to a partial default on the loan.
Needing a Bailout From Personal Contacts
If you fall behind on hard money payments, or the house does not sell fast enough, you may need a bailout from one of your private investor network contacts. These can be friends, family members, or other real estate investors.
Asking for emergency funding sometimes leads to trouble in therelationship. It is best to not have this happen by tapping into other sources of money in the event that a bridge loan or loan extension are required.
Hard Money Loans – The Ugly
Similar to what happened in 2008, an economic collapse can cause a flipper to be unable to sell the property within a year. This means they will have to find a way to pay back the hard money lender from another funding source.
The may need to dip into their own income (which could be hit by the economic downturn as well) or liquidate another property to cover their loan costs.
Inability to cover the loan can become a dire situation that will result in the loss of the property and a ruined credit score (if a personal guarantee was included in the loan package).
An earthquake, fire, hurricane, tornado, or flooding can destroy a property rehab or expansion project.
It’s essential to carry proper insurance with natural disaster coverage, even if you only expect to hold a property for a few months.
Arson or Vandalism
Past or current tenants of the property could set the house ablaze or vandalize it in response to an eviction. You could get a call from the fire department saying your property is a pile of burnt matchsticks.
Theft of copper wires and pipes, appliances, and even windows and doors, are common on rehab projects. It’s impossible to keep a guard onsite 24/7/365. Insurance companies know this and the cost of insurance can be high on fix & flip houses. If it is a foreclosure property, you may not be able to get arson insurance at all.
If the property is burned or vandalized and it isn’t insured, this will definitely eat up all of your profits. Basically always expect the unexpected when flipping houses using hard money.
The Hard Money Lender is a Shark
A sharky lender can spell disaster for hard money financed projects.
Loan sharks will attempt to take the property by forcing higher rates and terms unexpectedly, or not grant the funds when needed. This can lead to foreclosure of the property and the lender taking it to make a profit for themselves.
This is why using caution when committing to a hard money lender is best. Do a reasonable amount of due diligence and ask for recent references before committing to a lender.
These Pros and Cons of Hard Money Loans are Real!
Hard money loans allow for a quick infusion of capital for real estate investors, rehabbers, and flippers. But they have potential downsides. Real estate investors need to use caution and have a good plan set in place from the outset. If they do, they can make good investment returns using hard money loans.