What is Private Money?
The vast majority of real estate investing is done with private funds and not with bank funds. Think of the pool of private money for real estate investing as a series of concentric circles with YOU in the middle.
Beginning investors start with their own funds or with money from friends and family when they begin to invest in real estate.
Soon, the investor begins to run out of money and must turn to other sources in order to continue buying and rehabbing property. Unless the investor is unusually bankable, the next alternative is to look at a wider circle of acquaintances—the family doctor, attorney, chiropractor, dentist, golfing buddy, fellow church member, and as you make it known what you do investing in real estate the conversation may naturally turn to returns people can make passively investing in real estate compared to other types of investments. It may not take more than six or eight private individuals with spare cash in hand to provide the average full time real estate investor with enough funds for all the projects one can handle.
Many investors, however, do not have the network of friends and acquaintances with investable cash resources, and many do not have the networking skills needed to go out and find private money for real estate deals.
That is where a broker or consultant in finding private money comes in to play. The private money consultant has developed relationships over a period of time with a number of hard money lenders, hedge funds and banks that will do non-conforming loans to real estate investors. Unfortunately, this is a realm that is fraught with scammers, so the average investor will want to align with a broker who has the experience to weed out the scammers and pretenders. Private money consultants can also help the investor to shape their deals for the best possible return and to be the most attractive to money lenders.
What is a Hard Money Lender?
Hard money is just one subset of private money. Hard money lenders are professional lenders. In some cases they are former real estate investors who are now lending to other investors either in addition to doing their own investing, or instead of buying and selling real estate themselves. In many cases they have attracted other private investors or have received rounds of funding from Wall Street hedge funds in order to lend funds at higher rates to other investors. Like banks, they engage in arbitrage where they hold funds at a smaller interest rate than the rates they use to sell money to real estate investors.
Typically, investors with hard money loans will pay double-digit rates of between 10 and 18% simple interest annualized for periods of between six months and three years to bridge a period of time needed to rehab and resell a fix and flip property or to stabilize a rental and refinance a rental property. In many cases there will be no prepayment penalty so the borrower can go shopping for an exit strategy at any time during the loan period. Most hard money loans come with points up front. Most charge from 2 to 8% of the loan at closing in points. The points sometimes all go to the private investor lending the money as some insurance that they will get paid a return even if the borrower defaults. Sometimes these points are shared with the hard money lender or with the broker. If there is a broker involved that broker will generally charge between 1 and 3% at closing as well. In most cases the lender will expect the borrower to bring the fees to the closing table unless the loan is for a refinance of a property with lots of equity in it. The lender may also charge origination fees for underwriting the loan which may range from $1000 to $4000 depending on the lender, the size and complexity of the loan. There will also be the normal closing costs to pay a title company or real estate attorney for a title search and opinion, title insurance, recording fees and any liens the borrower has agreed to pay off. Most hard money lenders will finance up to 65% of the “as is” value of a property, or 80% of the purchase price, whichever is less. Lenders also want to make sure the borrower has enough cash on hand, or cash flow in a rental property, to be assured that the borrower can pay the monthly interest payments for at least several months into the loan.
As you can see, it does take some cash to close a typical hard money loan. The advantage of working with most hard money lenders as compared to a bank is that they are less rule-bound when it comes to sources for down payment and closing costs. Many will allow cross-collateralization, which is allowing a lien to be placed on another piece of property the borrower owns free-and-clear to be used just like cash in the transaction. Many lenders will allow the seller to carry-back a second mortgage to cover the down payment and closing costs. Borrowers can bring on board an equity partner with cash, or borrow funds from family and friends. Cash for closing may come from a 401k, the cash value in a whole life insurance policy, or a self-directed IRA. While most lenders will require a personal guarantee on the loan, some will allow a loan to be non-resource so that sources such as a self-directed IRA or trust funds can be used to pay the down payment or closing costs on a hard money loan.
A few lenders are now willing to fund “fix and flip” loans where from 80 to 100% of the rehab costs will be covered as part of the loan. In most cases the lender will escrow the rehab costs as delineated in a bid from a licensed contractor and will dole out payments as parts of the job is completed and certified by an inspector. Escrowing funds is one way both the lender and the borrower can be assured that the work as described in the estimate is actually getting done. Lenders who do rehab loans will generally only hold these loans for between 6 and 12 months and will often charge a higher interest rate or more points simply because these loans are considered more risky. They do not like to see “gut job” projects and may have rules that only allow for rehabs at no more than 20% of the After Repair Value of the project.
Rental and commercial property that are free and clear of other loans, or largely paid off, may qualify for a refinance loan. Refinance loans generally range from 50 to 65% of the “as is” value of the property. Lenders will order a third party appraisal to verify the current property value and the cost of this appraisal will be the one up front cost the borrower will need to pay for before closing. Appraisal costs vary from area to area but average around $400 for a residential property.
If you are looking for a reliable hard money lender, give RE Advantage Capital LLC a call and we will get you a rate quote from one or more of the hundreds of private lenders we have vetted. Call today at 319-988-1119 and we will do our best to get your loan accomplished quickly.
RE Advantage Capital LLC