Guide to Becoming a Hard Money Lender
Over the many decades, and through all of the ups and downs, real estate has been a tried and true method of building wealth. Anyone can succeed in real estate investment if they have a solid understanding of how it works. Let’s say that you made a killing in real estate, and now you are reaping a sizable profit every year. The next question should be, what should you do with the profit? No doubt you want to upgrade your lifestyle so you and your family can enjoy the good things in life. However, you still need to balance that with intelligent money management so the money coming in can keep growing for you. You do not just want to leave this money in a bank account because your money will not grow there. You can always continue with real estate investment, or you can invest with a twist. Another avenue of investment is becoming a hard money lender in real estate.
Many real estate investors like to take this approach because the investment is still backed by the same level of security and has great potential in generating a profit. However, the twist to this approach is that you do not need to acquire the property yourself.
Private Money Lending Explained
What does it mean to become a hard money lender? A hard money lender is an individual who uses his own money to finance a real estate investment of another person. A mortgage secures private loans against the property that is financed. The person who is borrowing money is borrowing it from a private lender instead of borrowing from a bank, credit union, or other conventional lenders.
In the old days, people sought loans from traditional lenders like banks, insurance companies, credit unions, pension funds, or government entities. However, real estate investors often found the loan agreement inflexible with a timeline that often did not suit their needs. Because of this, investors developed other loan options. People with the means saw this as an opportunity to provide better loan options to investors who found it too difficult to deal with big lending institutions. Private money loans have become a popular option in the real estate investment business. It is no longer an exception to the rule.
When you are new to private lending, you might start by lending to small investors. As you get more experienced, you can go for more expensive properties. As a private money lender, you can secure the loan with a piece of property that has a much higher worth than the loan’s value. In this respect, you assume less risk than if you own the property yourself. You must learn all about the options investors have to finance their real estate investment.
There are many advantages to becoming a hard money lender. If you take the right approach, you can keep your risk low and your potential gains high. Granted, this is certainly not a recommended course of life for everyone. You have to be honest with yourself and see if you can afford to be a money lender. Just because you made a profit from your ventures does not mean you should jump right in and make a loan to the first person who wants to invest in property. If you understand the process enough to know how to reduce your risks and know how to recognize opportunities when they come along, you might do well as a hard money lender.
Is Becoming a Hard Money Lender Right?
To determine if becoming a private lender is right for you, see if any of the situations below apply to you:
- You have experience investing in real estate, and you want your portfolio to grow.
- You earn a high income in your regular profession, and you have excess cash in the bank.
- You have a lot of money in your retirement account.
- You are currently retired, and you want an investment that can earn you a passive income.
- You own a sizable estate or a trust fund.
- You made a killing as an entrepreneur, and your startup was a huge success.
- You just won the lottery.
- You have a relative or a friend who needs money to buy a piece of property, you have the money to help him out, and you want to help him out.
If you are still pondering whether or not this is right for you, the information below will explain how private money loans work and hopefully address some of your concerns.
What Does A Private Money Loan Look Like
The concept is really very simple. The loan needs three things to work: the party that borrows money, the party that lends the money, and the right loan origination software.
Private money loans are great for borrowers who prefer not to or cannot get a loan from a conventional institutional lender. A private loan is similar to a conventional loan, but there are some differences. A private money lender can charge a higher interest rate for the loan, but he can also finance a loan that conventional lenders do not want to finance. In addition, private money lenders make faster decisions on whether or not they wish to fund the loan, and how they make their decisions is very clear.
Steps In Becoming A Lender of Private Money
Private money lending provides advantages for the lender and the borrower. Sometimes, a real estate investor who borrowed money from a hard money lender becomes a hard money lender because he sees the benefits. If this is something you would like to pursue, here is a high-level guideline of steps to take:
- Form your company and get the insurance that is required.
- Consult with an attorney on forming your company.
- Determine the focus of your loans.
- Join groups and network with other peer lenders to find leads to potential investments.
- When you find a possible client, analyze your potential gains against possible risks.
- Launch your hard money lending business.
Finding Clients Who Want To Borrow Private Money
Hard money lenders operate on a fundamental principle: lend money to those who need to buy real estate. To invest in real property, one needs money. Most investors do not have all that cash to fund their investment. Investors have to work on getting private loans constantly to keep their ventures afloat. Even if they have some of their own money, they often seek loans from a private lender. That is because they do not want to commit all of their own funds into one venture. With a private loan, they have more options and flexibility to expand their investment portfolio.
One significant advantage is that private loans are a lot faster to close. That means the borrower gets his money quicker. Speed is essential to borrowers because the timing of acquiring the funds can make or break a deal. Being able to secure funds quickly will make it possible to finalize the deal.
As a private money lender, you will encounter different categories of borrowers. They have various reasons for needing a loan, but they all need a loan. Here is a brief description of these categories:
Rehab property to sell
Otherwise known as flipping, this investor will buy a piece of residential real estate, renovate it, then sell it after the renovations are complete. This type of borrower likes to borrow private money because traditional banks will seldom finance a loan for property in bad condition. Private money can be obtained quickly, which is very important in flipping a house.
Rehab property to rent
This investor will buy a piece of residential property, renovate it, and rent it out to get rental income. Again, this investor likes to borrow private money because he can obtain the funds he needs quickly, and banks might not want to finance a property in bad shape.
Property developers and builders
These individuals buy vacant lots, get a permit, and build property on them. It can be for commercial or residential use. Developers and builders prefer borrowing private money because they can get the money quickly. In addition, banks often consider real estate development speculative, so they tend not to finance it.
Investors of commercial property
Banks often will not finance a commercial property loan because they consider this to be unstable. So, the commercial property investor will often use private loans as a bridge.
How You Reap A Profit From Private Money Lending
Both borrowers and private lenders like private loans because the terms can be as flexible as they agree to make them. In conventional loans, a lender gets income by charging the borrower interest on the loan. With a private loan, the terms can be anything that the lender and the borrower agree on. They can agree on how and when to repay the loan. A hard money lender can provide real advantages that are not available to investors from conventional loans. Here is how a private money lender can make a profit:
A joint venture is when the private lender and the borrower agree to split the profit generated by the real estate investment. The agreement will specify what percentage of the profits each party gets. All the conditions are outlined in the loan contract. A lot of private lenders intentionally seek out borrowers who seek joint ventures with the lender. As a private lender, you just have to be sure the investment has the potential for significant gains.
The exit fee is the set amount that the borrower agrees to pay when the loan term ends. It is usually a percentage of the cost of the investment. Sometimes, the fee can be adjusted to be higher, especially when the borrower needs extra time to pay off the private loan. In this case, the lender may charge a higher exit fee.
Just like conventional loans, private loans can charge interest. The private lender sets the rate when he approves the loan. This is a common way for a private lender to reap a profit from the money lent out. Interest rates are usually higher than what banks charge for conventional loans. So, private lenders find this very attractive.
If the borrower wants a lower interest rate, the lender may charge points to offset the rate. This is a fee that the borrower pays to get the lower rate. A lender will calculate points as a percentage of the loan. One percent is equivalent to one point. Private lenders like this because it allows them to collect a large sum off the bat, plus interest throughout the loan. Borrowers will often suggest this to negotiate for loan approval.
Helpful Advice From Seasoned Private Money Lenders
The bottom line is: as a private money lender, you are the bank to investors. You do not invest in the property yourself, but you can fund the investment owned by other investors. You can see the potential benefits of this hard money lending. Before you dive in, check out the list of tips below:
Start With Small Loans
Decide on a comfortable range that you would like to fund, and do not stray from your decision. One common mistake made by novice hard money lenders is getting into too many ventures too fast. Do a careful assessment of your risk tolerance and how much you can comfortably afford. Draw up guidelines on the projects you want to fund and if an investor presents to you a venture that is not within your scope. Refer him to see financing elsewhere.
Get An Experienced Lawyer
Just because you have money to be a private lender does not mean you know the laws behind lending. Hire an experienced real estate attorney to review contracts and for advice during negotiations. When you first set up your business, the attorney can help you set up some legal protections. The attorney becomes a part of your team. His advice will be very valuable to you in your venture.
Find Local Clients
Even though lucrative property deals are in all parts of the country, great deals can be had right in your neighborhood, too. If you send money to a local investor, you have the advantage of meeting them in person. Not only that, but the investor will likely contact you again for future ventures. Do not overlook your local market because a great deal might be just waiting for you. There is always time to expand later.
Be The Real Deal
Do not inflate your experience or your business ventures. Your deals bear you the best testimony, regardless of how experienced you think you are. When you present yourself to your client, always keep it honest and transparent. Avoid misrepresentation. Stick to your values and objectives.
Remember To Stay Informed
Although you are not buying the property yourself, being a hard money lender still makes you an investor. You need to stay informed about current market conditions, news in the financial world, economic news, and anything that impacts the real estate market. You still need to be financially astute with your decisions even though you are not directly investing in a property.
Study Hard Money Loans
Before leaping to become a private hard money lender, you will need to learn about the types of deals you want to invest in and what you consider worthy of financing. For instance, what kinds of rehab give you the best return on the investment? What is regarded as a good rental property? What properties are suitable for buying and holding? The more you learn about this, the more you can evaluate investment ventures that clients present to you. You can see beyond their pitch and get down to the bones of the deal to see if it will turn a profit. If you want to be an astute private lender, you need to fully comprehend the market conditions behind the deal to be financed.
Hard Money Lending Defined
As an alternative to a conventional loan, a hard money loan is another way to lend money to a borrower who wants to put up his real estate investment as collateral for the loan. Unlike a conventional loan, the borrower’s credit history is not factored in. A hard money loan only looks at the value of the property. Interest rates on a hard money loan are usually higher, but the borrower can get the money faster and easier in exchange. Property investors who have poor credit and who have a lot of equity in a piece of real estate will tend to borrow hard money. In addition, an owner who sees foreclosure on the horizon will usually borrow hard money.
Starting A Hard Money Lending Business
Lending hard money can be a way to generate income for people who have extra funds at their disposal. Be sure to assess your risk and perform your due diligence with any business venture. If this is a venture that you want to dive into, consider these steps:
- Create a business name and form your company
- Create a website for your company
- Form an LLC (limited liability company) with the help of an attorney
- Explore investment opportunities
- Create a business plan and guidelines on making a loan
- When presented with a loan opportunity, make some projections on the potential returns
- Open your business as a hard money lender
Advantages of Lending Hard Money
Becoming a hard money lender allows investors to participate in the real estate market without purchasing any property. Many lenders do not own a single property. It is a good arrangement for those who want the potential gains of a good real estate deal but do not have the time or do not prefer to deal directly with property issues.
Another advantage is that the lender has control over the loan terms and whom to lend money to. The borrower is subjected to the application process, negotiating terms, and loan approval. The lender calls the shots, and that is a very nice perk.
Disadvantages of Lending Hard Money
All business ventures come with some disadvantages. In hard money lending, the biggest hurdle is having enough money to lend. Most hard money lenders get over that hurdle by indirectly investing and managing real estate to generate substantial income. Over time, they accumulate enough capital to become a hard money lender.
Being a hard money lender is not without its risks. Because private lending is outside of conventional loans, the private lender can choose to lend to whomever they want. The lender bears the risk of lending to someone who may not qualify for a conventional loan for some reason. The private lender must create his own set of lending standards to screen potential borrowers to mitigate this risk. They need to research the individuals and properties and then form their own opinions on whether the borrower is a reasonable risk.
Private money loans can benefit both the lender and the borrower. The borrower gets quicker and easier approval and better access to funds. The lender benefits from getting access to lucrative deals with potentially high gains. For both the lender and borrower, private loans are a great alternative to build wealth.
If you are considering becoming a hard money lender, we hope you found this article informative. When you are ready to move forward with your new business venture, contact Liquid Logics. We provide the most flexible, robust, secure, and powerful cloud-based loan management system for private and hard money lenders.