Most often, a person looking for a loan will go the traditional route, opting for a bank, credit union, or other large financial institution. Terms may or may not be strict, interest rates vary, and the approval process may take 30 days or more. This is great for many circumstances.
The other option is to go to a hard money lender. These are usually wealthy individuals who fund people like real estate investors. These lenders will loan the investor an amount equal to some percent of the fair market value of the property after it’s repaired-usually up to 70%. This amount is expected to be enough money to purchase the property and pay for at least a portion of the repairs.
Knowing when to work with a hard money lender depends on an understanding of what the loan’s terms are. This can vary greatly from person to person, but there are some general trends that can be useful to know in the decision phase.
For one thing, hard money loans don’t have to go through the bureaucratic process involved in a traditional financial institution. As a result, the funds can come through quickly. This is extremely beneficial for younger real estate investors who need to buy a property before it gets snatched up by someone with a more established bank account.
It’s also important to know that a hard money lender will generally charge higher interest rates and closing costs. The exact number depends on your credit score, but the interest rate can run as high as 20%, and it can be up to 10 points for the closing cost. So, while the money will appear more quickly, a young investor needs to know that he or she can repair and sell the property quickly so as not to accrue too much interest. If you’re considering this option, make sure you have a repair crew on standby.
Finally, you need to understand a few of the risks involved. A hard money lender is very different from a traditional institution in that the lender is not part of a large bureaucracy. This is a person with some wealth who wants to make smart, safe investments. While there are some significant benefits to this, the flip side is a lack of predictability when compared to a bank. The lender might just decline your request at the last minute, or they might take more time than anticipated to carry out the transaction.
This is not to discourage anybody from going this route; the point is that you need to do your research. Try to find as much information as possible on this person’s reputation and make sure you take precautions. Moreover, realize that this lender is taking a risk to help finance your project, and they are likely also taking precautions. If time is a huge factor, or if you absolutely need the funding right away, you may want to consider going a different route or putting off a given investment. Either way, the cash is out there, and going to an independent investor can be an excellent option.