If you have experience with fix-and-flip real estate projects, you’re probably well familiar with hard money loans. In fact, they’re the preferred method of project financing for many real estate investors for short-term projects. If you’re not familiar with hard money loans, you should keep reading. Their popularity is due to the fact that they are easy to get, they don’t rely solely on your credit score or assets, and they are a much quicker alternative to traditional methods for financing the purchase of a home.
But before you jump headfirst into the pool, first consider if they are the right method of financing for you. Here are some things you should think about.
- Do I Have an Exit Strategy in Place?
Perhaps the biggest mistake you can make when choosing a hard money loan is doing so without any real plan in place. Hard money loans can be a great source of financing, but not without an exit strategy – either from the property or from the loan.
If you’re borrowing funds for a fix-and-flip investment, you should already have a solid plan to complete renovations and secure a buyer, even before you seek the funding. Likewise, if you’re borrowing to secure a property to keep and rent out, you should have a detailed strategy for refinancing or otherwise fulfilling the hard money loan when it comes due.
- Will the Short Loan Term Work?
Most loans, especially on fix-and-flip transactions, range from six to eighteen months. The term can depend on the property and your specific situation, but is only meant to fulfill the needs of short term projects. Hard money loans are ideal when you need quick access to money and you’re able to repay the funds in a short period of time. This works well for many real estate transactions, but not all of them. Before deciding on a hard money loan, look at your plan for the property and decide if the terms available will realistically fit your needs.
- Are Other Financing Options Available for this Property?
Hard money loans are not the cheapest way to finance real estate deals. They are, however, often the only legitimate option available depending on your timeline and financial history. This is because traditional lenders won’t loan money on many fix-and-flip properties. Homes in disrepair, even if they have great earnings potential, are commonly denied funding based on their current state.
Hard money loans can also be the only feasible choice to fund a real estate transaction when borrowers don’t meet the lender’s stringent requirements. For investors with spotty credit or other factors preventing them from getting approval, traditional mortgages and loans may be out of the question. For investors with good credit that meet the lender’s standards, traditional mortgages and their lower costs may provide better value.
- Is it the right alternative for your needs?
Many hard money loans include not only the amount needed to purchase a property, but provide extra funds to cover the costs of renovations. You can also close on hard money loans in as few as seven days, whereas traditional mortgages can take weeks or months. On tough deals with difficult sellers or stiff competition, the ability to close fast could mean the difference between getting the property or missing out.
- Have I Included Fees and Interest Charges in My Calculations?
Even if a hard money loan seems like the best, or only, choice for your deal, it’s still important to conduct your own calculations and due diligence. Financing costs can play a significant role in the overall profitability of a fix-and-flip. When there is a wide margin of profit for a property, the costs of hard money lending may be insignificant, but they can also erode earnings quickly on transactions with less wiggle room.
Don’t rely on ballpark estimates or back-of-the-napkin scribbling. Sit down and calculate out exactly how the fees and higher interest associated with a hard money loan will affect the outlook of your investment. Create multiple scenarios based on different events such as a longer holding period or cost overrun to ensure that you’re not setting yourself up for potential disaster.
Hard money loans will often prove to be a great way to finance your real estate deals. As an investor, however, it’s important to understand that they’re not always the best choice, and should be part of a diverse set of financing options. By asking yourself these five questions before choosing a hard money loan, you can determine if they provide the right type of funding to fit your current project’s needs. Do yourself a favor and find out more about how hard money loans work, as well as how you can benefit.