Hard Money Basics
Diversified Capital Consulting loans are non institutional loans funded by private real estate investors, companies and funds - using their own money - secured by a first or second Trust Deed against the subject property.
These types of loans are referred to by many different names, such as, private money, private equity, equity, equity only, equity-based, equity-driven, or asset based.
Equity-driven mortgage loans typically require 35-50% equity in the property and/or collateral in another piece of real estate, although some lenders will accept other assets such as stocks and bonds as collateral for the loan.
These types of loans also carry a heavier burden and interest rate for the borrower for the simple reason that they also pose higher risk for the lender and are often a temporary solution that opens doors for a more permanent financial solution or exit strategy.
Equity based loans offer an alternative to strict and narrow traditional bank (institutional, conventional) financing, thereby eliminating many of the usual qualifying, credit and income underwriting guidelines and delays of banks, mortgage companies or institutional lenders for traditional mortgage loans.
Equity lenders base their decisions on the unencumbered property value, its marketability, the borrower's exit strategy and his or her ability to repay the loan. They generally do NOT calculate debt ratios and usually do NOT take into account the borrower’s credit and income. Funding is very fast; sometimes within days of receipt of the application - a true advantage over traditional bank financing.
History
Hard Money is a term that is used almost exclusively in the United States and Canada where these types of loans are most common. The term "Hard Money" generally infers that the borrower has actual “hard” cash invested.
The hard money industry began in the late 1950s when the credit industry in the US underwent drastic changes.
The hard money industry suffered severe setbacks during the real estate crashes of the early 1980s and early 1990s due to lenders funding properties at well over market value. Since that time, lower LTV rates have been the norm for hard money lenders seeking to protect themselves against the market's volatility.
Legal & Regulatory Issues
From inception, the hard money field has always been formally unregulated by state or federal laws, although some restrictions on interest rates (usury laws) by state governments restrict the rates of hard money.
Credit
Conventional and sub prime lenders rely on a credit grade system or “FICO” score. The FICO system is a complex matrix measuring over 30 different variables in an individual’s credit profile. The FICO system converts the profile into a numeric score, which is added to an individual’s credit report. That score is a reflection of the computer assigned credit risk for that individual. The intent is to reduce the amount of subjectivity underwriters (credit decision makers) inject into the risk analysis process.
Borrowers with a score below 720 usually find themselves locked out of the best loan rates and terms offered. Typically, borrowers with a score below 500 are locked out of the Conventional and sub prime market altogether.
Unlike conventional and sub prime lenders, Hard Money Lenders rely on the equity position in the property to guide their credit decisions.
Qualifying
In all cases, the general qualifying process is the same: the investor/lender uses real estate as collateral. The real estate is reviewed to determine whether it holds sufficient value for the investor/lender to be willing to take the risk of making a loan based on this collateral. The borrower's financial state and future potential is reviewed to determine the risk factors present. And finally, an exit strategy is reviewed to determine whether the loan will be completed satisfactorily within a given time frame. Depending on the results of this due diligence process, the investor /lender determines whether - and at what rates and terms - to fund the loan.
How to use Hard Money Successfully
Having a hard money lender on your side when you are purchasing investment property will help you become more profitable. You will be able to take advantage of opportunities as they become available. Have you ever found a property with great equity and wished you could submit an offer immediately, knowing you could close within ten days? Being pre-approved with a hard money lender would allow you to do this.
To be able to make multiple offers on many distressed properties listed with real estate agents, you will need a “Prequalification Letter” to submit along with your offers, particularly if the properties are REO properties (foreclosed properties owned by banks or mortgage companies). So many investors make offers on REO properties and never carry through to closing. This makes the agents and foreclosing lenders suspicious of all investors. Once you have been pre-qualified by your lender for a hard money loan, your offer will carry more weight. The agent and the mortgage company will take you more seriously knowing that you can actually close on the property. Most of the agents who deal in foreclosed properties will come to recognize you as a player in the real estate investment game, and call you with deals others won’t even know about. You can now make lower offers with some assurance that more of them will be accepted. You will also be confident that you can close and either rehab or wholesale the property.
What about when you sell properties to other investors? Will you need a hard money lender then? The answer is yes. Your relationship with your hard money lender will be your best and most reliable resource in making sure that your deals get to the closing table. You are the liaison between the Buyer and his financing source. Many prospective buyers for your wholesale properties cannot pay all cash, even though they sometimes claim they can. Most cannot simply write you a check from their checking account and will have to borrow their funds. How many of you have tried to sell a property to an investor and signed a contract only to find that your buyer is applying for a conventional loan? How many of you have waited weeks or months while your buyer tries to qualify for financing? In cases like this, it is your job to take control and lead them to the money. Many wholesalers develop a steady stream of investor/buyers because not only do they find the properties, but they help line up the financing.
Hard Money Lenders are a great resource for real estate investors, whether you are a beginner or a seasoned pro. Having a hard money lender working with you enables you to confidently make offers you could not ordinarily make. Hard Money enables you to carry through on your offers when they are accepted, and provides you with the funds you will need to rehab the project if required.
When you make your cash offers for a house you’ll never want to offer more than 70% of the “after repaired value” (ARV) less the cost of repairs. Hard Money Lenders will usually lend 50% - 70% of the ARV. The loan is an all interest loan for the purchase and rehab of investment property. Most hard money lenders understand the real estate market, real estate loans, and mortgages and are looking for a safe secure investment with a better return than what can be received from a bank. Look for a lender with whom you can build a relationship. The better he knows you, the better deal you will receive.