Buying an Investment Property? Hard Money Lender or Traditional Mortgage...which is better?
Updated: Jan 11
A hard money loan is usually through a private lender who will charge higher than normal closing costs and higher than usual interest rate. This is popular for those properties that need to be purchased quickly. Using a private lender generally requires very little paperwork, and
if the numbers work for the lender, the deal can be closed promptly with little or no hassle.
The hard money lender may set a “balloon” payment after one year, because they want to get all of their money back quickly. All hard money lenders use some form of balloons. Here is one of the differences from using a Traditional Lender. Traditional lenders will spread your payments over 30 years, with a lower interest rate. You will be paying a higher-than-normal interest rate for the hard money lender taking on a greater risk, and you wanting to close quickly.
The smart thing to do if you deal with a hard money lender is to:
• Only use this form of lending if you need to close on the deal quickly.
• Make sure that your after-repair value is 30% to 50% above the purchase price of the property, including renovations and closing costs. You will need this large cushion in case your renovation costs come in higher than expected. You always want to be prepared for the unexpected. The property may need more work than you anticipated, or the weather might not be cooperating with your roofers. Every payment that you make to your hard money lender, every month will be cutting into your profits.
• Always have an exit strategy in place, even before you close on the property. Many times I have had several contingency contracts in place before I close. So, I know I have someone who is willing to buy the property from me, after renovation. This assures me and the lender that we will not be stuck with the property for a long time. I also, have refinancing in place for myself. So, that if any of my contingency contracts fall through, I can refinance the loan to bring it to a conventional loan with a better interest rate, and keep the property, or sell it later at my own pace. This is prior planning to have in place so that you don’t get caught in a position of not making a profit or lose your home to a hard money lender when that nasty one-year-balloon comes up.
Tip: Do extensive research when you are looking for a hard money lender. There are many companies online that will hit you with upfront fees and may not ever close your loan. Find out who other investors are using and what fees are associated with the closing.
Tip: Have an exit strategy in place from day one. Hard money is expensive money. For the convenience of a quick closing with less paperwork, you are paying more in closing costs and monthly interest rates.
You want to know in advance of purchasing the property if you are going to flip it really quick within 2-3 months, or rehab and sell later in the year, or refinance after a year to pay off the hard money loan and keep the property as a rental.
Tip: See if the hard money lender will include rehab money in the purchase and how much they will include. You may acquire a property that needs some work, and you will want to see if the maximum amount that the lender will include in the loan. Importantly, you will want to see if they will advance you the rehab money up front, or if you have to do the work first and then get reimbursed.
You will have to factor all of this in your initial budget to see how much of a profit you will make.
Carl Agard is the Publisher and Editor in Chief of Boss XL Magazine and the Author of the new Book "Financially Surviving COVID19 (Finding Gems in the Real Estate Market)"