Hard money is expensive, but it’s often well worth using to do real estate deals – whether it’s funds to do a double-close on a wholesale deal, money to finance a fix-and-flip, or take-down money to buy a rental (which you would refinance at a better rate later.) After careful analysis that the numbers work, you’ve determined that going the hard money route is the best way to go. What questions should you ask?
- How long have you been in business?
Look for someone that has been around for 3 years or more. By then, they will certainly know what they are doing
- How many loans do you do in a year? How many loans do you have outstanding right now? How are these loans performing?
There are no specific answers you are looking for with these questions, but you are trying to figure out how strong their underwriting is, and more importantly, try to get a feel for the lender’s intent. Some hard money lenders want the people they are lending to, to succeed. They are true win-win partners. Other hard money lenders are looking for those they lend to, to fail. They want to charge late fees, penalties, and in some cases, they want to foreclose on the property. Usually, when you ask how their current loans are performing, you’ll get a feel for their intent.
- What are your terms?
- They should at first tell you how many points they charge. Each point is one percent of the total loan amount. So for a $120,000 loan, a 3 point fee would be $3600. They usually call the points an “origination fee.” We usually see hard money lenders charge between one and five points. Then, they should tell you the interest rate. Usually they calculate this as “simple interest” and it can range from 10%-20%. It can be expensive! Be sure to clarify and understand: How do you calculate interest?
- Can I roll the points or interest into the loan?
Some lenders will allow you to roll the points and interest into the loan so that it is paid when you pay off the loan. The ‘pro’ of this approach is that you may not need to come up with any out-of-pocket cash; the ‘con’ is that you will likely be accruing additional interest costs on the points and the previous month’s interest.
- What is the term (length) of your loan? What is the penalty to extend? Can you extend the loan?
Most hard money loans have a term of 6, 9, or 12 months. If the loan is not paid back in the given timeline, there are penalties.
- What is your down-payment or equity requirement?
Some lenders will pay 100% of the costs. Others require some “skin in the game” (some cash from you), to know that you won’t “walk from the deal.”
- Do you fund construction? If so, what percentage do you fund?
Some lenders will even fund a portion of construction, usually 70-80% of construction costs. If they do fund construction, ask: Do you have a draw procedure?It is likely, that you will need to provide a detailed, itemized construction budget. They will fund a portion of the construction in a “draw.” Once you sped that money, you call them to come view the construction progress and to see your receipts for work completed. Then, they will fund the next draw until the construction is completed.
- Is there a prepayment penalty? What if I pay the loan early what will I be charged?
Some lenders figure their returns based on the full length of the loan. If you pay early, they won’t make the money they thought they would, and they want to penalize you for that. Some lenders disguise prepayment penalties with other crafty terms. Be sure to read all documentation before you sign it. I got burned with a $6000 prepayment penalty on one loan!
- What do you need from me to underwrite the loan?
In theory, the lender is basing the loan on the deal – not on you or your credit. They should not need to run a credit check, but some still do. Likely, they will just need information on the deal – a proforma of the deal (purchase price, construction costs, after repaired value (ARV), estimated profit) and any information on the particular property.
- Can I get three references from you from people that have taken out loans with you?
Always call at least three recent references. You’ll probably learn more from the references than from the actual lender.
By asking these questions, you should have a thorough understanding of the hard money lender’s conditions and intent. It’s always advised to check with your real estate attorney before signing any legal documents.