12–14 minutes to read

Are Hard Money Lenders a Good Idea?

A few months ago, I saw a killer bargain listed in the MLS.

The home was in the suburbs of Memphis, TN, a few miles away from my home.

8174 Old Brownsville, Rd.

The listing agent listed it for a quick sale of $144,900.

After a quick preliminary review of the neighborhood comparables given to me by my Realtor, I saw that the home easily had an after-repair value of $210,000 and could be flipped within 90 days.

My Realtor and I walked through the home and I quickly saw the obvious needed repairs. The home needed a new paint job, hardwood floors and carpet, new kitchen counters, a new window, and only a few other things which could have been taken care of with a total budget of $20,000.

Unfortunately, I knew from my experience with past homes in similar conditions that no conventional lender would have loaned out the money for the home in its condition.

So, I needed to look for unconventional financing to fund the deal.

My first thought was to obtain an unsecured personal loan for $100,000 and use this in conjunction with my personal savings. I prefer investors use an unsecure loan for their deals because it’s much easier to get the funding when compared to conventional real estate financing methods.

But, I had applications pending at a conventional lender for two other investment properties at the time.

I didn’t want my credit pulled and I didn’t want to spend the majority of my cash reserves.

If my credit was pulled to obtain a new loan, I would have had to explain it to the conventional lender, who would have, in turn, calculated the new loan payment to determine a new debt-to-income ratio. This could have affected underwriting’s approval of my loans. If I used the majority of my cash reserves, I would have been ill-prepared to handle any large cash emergencies in my new investment properties.

So, I decided to seek other financing through a hard money lender.

What is a Hard Money Loan Lender?

In the real estate investing world, a hard money lender is usually a private individual or group of private individuals that lend investors money based on the value of the underlying property, as opposed to their credit score. However, their fees are usually much higher than a conventional lender.

I personally didn’t know of any hard money lenders so I went on Bigger Pocket’s real estate community website to search their list of sponsored hard money lenders.

Having never used a private lender but anxious to put an offer on my new golden find, I found a hard money lender and filled out the application for $125,000.

I didn’t even consider the amount I would end up paying for the loan.

A quick, rough estimate in my head calculated the number around “yep, I’ll profit from the flip.”

I just wanted to get a pre-approval letter as quickly as possible so I could put in my offer to the listing agent.

What were the Hard Money Loan Requirements and Interest Rates?

The hard money lender that I chose had a seemingly easy process.

The requirements were pretty simple.

I provided some preliminary information about the home, upload a few pictures, told them about my real estate investing experience, and then clicked through their terms of service.

In a few minutes, I was given a preliminary approval of 19% for a 6 month loan at $125,000.

But, there was a 90 day interest paid minimum requirement.

So, even if I had sold the property in 30 days, I still would have had to pay 90 days of interest on my loan.

The rate seemed excessive to me, but I couldn’t really complain. I was fueled by my drive to quickly secure my property.

I only focus on the fact that I was going to make money on my deal regardless, so 19% was relatively cheap, relative to the money I didn’t have myself.

I was hyped.

At this point, I didn’t see if there were any other charges, but I knew there were. They just weren’t listed in my profile’s dashboard at the time.

Later though, I found that in addition to my 19% interest rate for 6 months on the $125,000, there was a 3% origination fee and a 1.5% service fee.

Hard Money Loan Example

For the lender that I was going to use, here were the numbers:

Loan amount: $125,000

6 months of interest at 19%: $23,750

2.5% origination fee: $3,125

1.875% interest rate: $1,875

Total loan amount if kept for 6 months: $28,750

Would I had been profitable with this Hard Money Lender?

In short, I didn’t end up getting the home.

I had offered only the list price.

I was outbid and ultimately an offer of $151,000 was accepted.

It was my lucky day.

Going into this deal, I just knew that I would have been profitable, but after running the actual numbers…after the fact…I realized that the only people who would have made out on my deal were the lenders and the selling agent.

Here are the numbers assuming I sold the property for my estimated sale’s price of $210,000:

Purchase price: $151,000 + Estimated rehab costs: $20,000 = $171,000

(Acquisition costs) – (After-repair selling value: $210,000) = $39,000

Gross profit: $39,000

The gross profit estimate looks great doesn’t it? And that was my problem. I didn’t even consider the cost of financing and selling the property.

(Gross profit: $39,000) – (cost of financing for 6 months: $28,750) – (6% of sale’s price realtor fee: $12,600) = $-2,350

Estimated Net Profit: -$2,350

What’s missing from the above estimated net profit?

(Closing cost: $2,000) + (holding cost such as utilities ($200 per month): $1200) + (any other miscellaneous costs) = -$5,550

Final Estimated Net Profit (Worst case estimate): -$5,550

Bottom line, I could have bought myself a 6 month stressful job of flipping a property with ZERO profits.

Other Hidden Cost of Using a Hard Money Lender

With only $125,000 funded with financing, I still would have had to use at least $26,000 to close the initial deal, and then another $20,00 for the rehab. So, a total of $46,000 would have been tied up in this project. This is money that could have been used to source other, more profitable deals.

Aside from tying my money up into one project, the hard money lender that I was going to use secures their loan with the underlying property. In other words, they put a first “mortgage” lien on the property, and if I couldn’t have sold the house within the 6 month loan period, the entire loan balance would have been due. The lender would have had the right to foreclose and then take the property, taking it along with the $46,000 that I would have put into the project.

Are Hard Money Lenders a Good Idea?

Obviously, the numbers above use a worst case scenario for THIS deal, and there are plenty other hard money lenders with different funding requirements.

Rehab costs could have been lower, I could have sold the property in fewer than 90 days, and I could have used a listing agent who only charges 1.5% (My Realtor charges me 1.5%).

These numbers would look a bit differently:

Rehab: $10,000

90 days interest: $11,875

Realtor fee of 4.5%: $9,450

3 months holding cost: $600

Net Gross Profit (Better case estimate): $20,075

Somewhere between -$5,550 and $20,075 lies the truth of my would have been net estimated profit.

But remember, everything is an estimate of profit or loss until the deal is done.

Conclusion

In the end, using $46,000 (estimated cash to close plus rehab) of my own money to yield $20,075 (or -$5,550) would have been a great return on my investment 43.64% (or -12.06%), if all went well.

So, I’d conclude to say, “given a best case scenario, hard money lenders can be a great idea.”

But you have to run the numbers and do your own due diligence…before putting an offer on a deal.

If I would have applied these calculations beforehand, this decision would have come down to one question:

Is this hard money loan worth the risk of earning only a negative ROI after putting in 6 months of hard work into this real estate project?

I probably would have concluded no.

Question: Have you used a hard money lender? What was your experience?

 

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