Obtaining money the hard way…
So let’s say you’ve gone the traditional financing route for investment property, and approached your bank for a mortgage. And you’ve been turned down – due to any number of factors: poor credit, too much outstanding credit, not having enough income to pay for the monthly debt service on the loan – whatever the reason, it ain’t going to work with your regular lender. Let’s also assume you’ve asked the owner of a property you’re interested in acquiring for seller financing…that is, let them finance the first mortgage on the property. While this is a great way to increase your leverage on any investment property, it’s also quite rare to find sellers desperate enough to offer owner financing. In addition, the seller needs to own the building free and clear, with no outstanding mortgage on it for them to offer seller financing.
The last resort?
If these financing routes aren’t working, and you simply don’t have the cash on hand to pay all cash for the property, regardless of the condition, then it’s time to seriously consider using the services of a hard money lender. As I’ve suggested in prior articles here before, “when you’ve exhausted all other avenues of property investment loans, crunch the numbers to see if hard money lenders will make a deal workable. Usually used if you have poor credit, or poor cash reserves, as their name implies, you’ll pay for the privilege of doing business with hard money lenders. Their investment mortgage rates are usually at least double conventional mortgage loan rates. And their points charged (pre-paid interest) can be triple or quadruple conventional points charged.”
When all else fails…
Sometimes hard money lenders make perfect sense when all other financing avenues are dried up, and you really feel you’ve found an excellent income producing property. And you want to jump on it by making a quick offer. I have seen some hard money lenders who don’t simply offer high interest rate, short term loans. I have discovered, and run into, some who would like to become your “partner.” One could say that the sheer hard money definition is like that of a loan shark. Be very careful if you find any hard money lender offering financing, but requiring a “back-end” amount when it comes time to sell your property. I had the occasion to inquire of a hard money lender once, and they were quoting me terms that were gangster-like in nature. These included: only financing fifty percent of the purchase price, a ridiculously high interest rate, with a two year balloon mortgage. Oh – and they wanted fifty percent of the gross profit upon the sale of the property when it came time for you to sell. Obviously, any novice investor should stay away from this kind of predatory hard money lender.
Private investors as hard money lenders
So how exactly would I define hard money loan? Simple: swimming in shark-infested waters. Consider how I have also previously cautioned here how “the average hard money investment property loan is supplied with capital put up by private investors – usually as a pool of money that is used to drive much greater profits for its investors. This private capital is traditionally unregulated…many consider hard money lenders as sharks feeding off the misery of those in bad financial straits. As a property investor, you will certainly need to approach any hard money investment property loan with a great deal of caution and foresight prior to signing on the dotted line.
Leveraging and hard money loans
If you have the cash on hand, you may feel it’s simplest to pay all cash. However, you lose the ability to leverage in so doing. I’ve noted before how “while paying all cash for a property is the “safe” way of investing, it provides no way to leverage your financial strength. Assuming you could not obtain conventional financing, hard money lenders offer the next best alternative to all cash deals. While your cash flow will be severely impacted because of the relatively exorbitant interest payments on hard money loans, even a small positive cash flow will yield great leverage over several years of making timely payments on the loan. Remember, besides the cash you put up on the property as your down payment, you will be paying off the principal on your hard money loan each month – thereby helping to increase your return on investment (ROI). Over several years, a small positive cash flow will yield much greater ROI’s than an all cash purchase would.
Paying through the nose?
If you’re going swimming amongst the sharks, your protective shark cage is knowledge. You need to know ahead of time that typical hard money loans carry interest rates that can run anywhere between 12 and 18 percent. Balloon payment are de rigeur, and these mortgages usually come due within 1 to 3 years. In all but rare instances, hard money lenders require being in the first mortgage position, so they can get their money out first if you default.
In addition, typical loan-to-value (LTV) ratios on hard money investment property loans range between 50% to 65%. And this LTV is based upon the “quick sale” market value of the property…that is – what the property will fetch today – not three months from now after you’ve fixed it up. Another potentially scary cost to take into account are points (up front interest charges). Typically, they can run anywhere between 4 to 8 percent of the total mortgage amount.”
Swimming with the sharks
So is a hard money loan for you? Well, that depends…mostly on your ability to perform under financial pressure. And believe me, there will definitely be more financial pressure utilizing the services of a hard money lender than a commercial bank. I’ve written in a prior article that “as a borrower, the hard money loan is definitely not for the faint of heart. You should already be comfortable taking on more debt, especially of the short term variety. You should also be well aware of the consequences in case of default. The hard money lender takes on the increased risk of borrowers with less-than-stellar credit. For this, they are able to charge exorbitant interest rates, with onerous terms, and even more Draconian conditions if the borrower defaults.
A mature, responsible investment property investor/borrower should not be scared off by the terms of a hard money loan. They realize they can use the leverage to their advantage to help grow their real estate holdings. And they enter into hard money investment property loans with eyes wide open.” So you really need to ask yourself, “am I of the right temperament for such an endeavor?” If the answer is yes, then by all means, jump into the ocean…and keep swimming fast…
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