Hard money loans are perfect for investment properties. You can get hard money specific to the types of loans you need, like fix and flip loans, property rental loans, and loans for land. If you’re unable to secure a traditional bank loan, hard money loans are also an option for primary residences
Unlike traditional loans, hard money loans are short-term loans with a fast-tracked approval process and require fewer hoops to jump through. However, while they’re not as stringent as their conventional counterparts, hard money loans come with their own special requirements.
In this post, I will discuss the different loan requirements for hard money loans and traditional loans, and what hard money lenders usually require from your side.
Let’s get started with this post.
Understanding Traditional Loan Restrictions
Hard money lenders aren’t bound to the same restrictions as conventional loans. Conventional loans must follow the guidelines set by Fannie Mae and Freddie Mac, two government-sponsored enterprises. These two enterprises purchase lenders' real estate notes, and conventional banks' loans always follow their guidelines. If they don’t, traditional lenders can’t sell the notes. As such, traditional lenders have many stringent requirements, and an approval process usually takes at least a month.
If you want a traditional mortgage from a bank or credit union, you’re going to need a:
In addition, you’re almost guaranteed to need to show recent pay stubs or proof of income, copies of your W-2s, and pass an extensive background check. If the processor or underwriter has any questions about your tax information, collections or judgments, or discrepancies in your income or credit history during the approval process, you'll need to answer them ASAP.
As long as you meet these requirements and the approval process goes smoothly, you can qualify for a conventional loan.
However, conventional loans aren’t the right fit for every situation. If you need short-term financing, or don’t qualify for a traditional mortgage, applying for a hard money loan is a better option.
Hard Money Loan Requirements
Since hard money lenders don’t have to worry about Fannie and Freddie, they can be more liberal with their requirements. The most basic hard money loans only have two requirements: a reasonable loan-to-value ratio (LTV) and a tangible asset(s) that can cover the loan’s cost if you end up defaulting. However, most hard money lenders have more requirements. Depending on who you work with, the better your loan’s interest rate and terms will be.
Here are the ten requirements I’m going to cover, so you know what to expect:
1. Tangible Asset(s)
Hard money loans are asset-based loans. In other words, you need a physical commodity with a clearly defined value to use as collateral. Often, that collateral is real estate property or land, but some hard money lenders are open to other physical assets.
The risk here is that if you default on your loan or are otherwise unable to repay it, your hard money lender can take your collateral to help recoup their loan. Even though this could happen, hard money loans are still considered a greater risk than traditional mortgages, hence why these loans have higher interest rates.
2. Reasonable LTV Ratios
While traditional mortgages examine your DTI ratio to determine if you can repay your loan, hard money lenders are far more interested in your property’s value. A hard money lender’s goal is to make a quick return on their investment. Your LTV ratio is one of the primary factors they consider when determining your ability to repay your loan.
Your LTV ratio is pretty straightforward. Let’s assume you’re looking to fix and flip a distressed property. The property costs $140,000, but you’ll only need a loan for $120,000. Once you remodel it and make it as valuable as the houses in the rest of the area, you estimate the property will be worth $220,000—that’s your after-repair value (ARV).
To determine your LTV ratio, you divide the loan amount ($120,000) by the after-repair value ($220,000). $120,000/$220,000 = 54.5%.
Many hard money lenders have a set percentage your LTV ratio needs to be under. Often, it’s 70% or less, but the number varies. Their logic is that an LTV ratio of 70% will discourage you from walking if things go sideways.
3. The Size Of Your Down Payment
Some hard money lenders will finance your investment 100%. These are usually special situations and usually come with higher interest rates. You’re probably more likely to get fully funded when working with private investors instead.
Since your loan is backed solely by the property you’re purchasing, the down payment for your hard money loan is typically larger than what a traditional lender requires. In some cases, you’ll need to come up with 10% - 25% of your purchase price, while others may require more based on your credit history and renovation costs.
4. A Detailed Repayment Strategy
Hard money loans are short-term loans you often repay in 3 - 36 months. You need a repayment strategy from the get-go.
If your loan is for house flipping or construction you plan on selling after completion, your strategy is easy: to sell the property before the end of your loan’s term. Between getting the loan and selling the property, all you have to worry about is keeping up with monthly payments.
If you’re seeking hard money financing for a commercial or rental property, or if you’re having problems selling the property within the loan’s timeframe, you'll need a Plan B. You can either try to secure a more conventional loan to cover the cost, or reach out to private lenders for help.
5. A Reputable Hard Money Lender
Hard money lenders are private investors and businesses—and they’re certainly not all created equal! Some hard money lenders can get away with predatory practices, because they’re not as well regulated. If you’re looking to buy your first investment property, or you and your partner are seasoned hard money borrowers looking to buy in a new area, I strongly recommend doing your research.
If you know real estate agents, house flippers, or other real estate investors in the area, ask who they know or prefer to work with. Look up reviews for hard money lenders on sites like Yelp and Google. Don’t limit yourself to their web page, because most hard money lenders will cherry pick the best testimonials to showcase on their site.
When navigating their site, you should look for how much information they share about their company:
Most of the best hard money lenders will have this information easy to find on their websites.
You should also ask about their:
6. Personal Finances
Many hard money lenders don’t dive into your credit history or require income tax returns from the previous two years, but some will. Hard money lending is a risky business, and some lenders will require you to provide extra information for their peace of mind.
Hard money lenders usually hate resorting to taking your collateral. It’s to their benefit that you can repay your loan at the agreed upon interest rate. Having a better idea of your general income helps them determine whether to loan you money.
7. Real Estate Investment Experience
Arguably more important than your personal finances is your real estate investment experience. Hard money lenders will feel much more confident in your ability to repay your loan if you’re an experienced investor. You’ve probably done the research, learned a few things, and have a much better idea of how much it will cost to renovate or construct the property in question. Also, your timeline and ARV estimates are more likely to be accurate.
Real estate investment experience also benefits the borrower. Since hard money lenders tend to be more confident in your abilities, you’re more likely to secure a loan with a lower down payment, reduced closing costs, and (depending on other factors, like your credit history) lower hard money loan rates. You may also have access to specialty loan programs and more generous loan repayment timelines. It all depends on who you work with and the terms you negotiate.
8. An Action Plan
Even the most savvy real estate investors need an action plan when taking out a hard money loan. You need:
The better prepared you are, the better your hard money loan options will be.
Speaking of being prepared…
9. A Well-Crafted Pitch
Gather all the information you’ll need for your pitch, and create a slide deck, an introductory video, or another visual to show during your presentation. Highlight all the information listed in your action plan (or as much of it as possible). If you’re an experienced investor, include before and after of your previous successful projects, numbers, testimonials, etc. You’ll also need to anticipate the questions private lenders will likely ask, including:
By the end of your presentation and the Q&A session that follows, the hard money lender you’re pitching should have a clear understanding of your plans and how you’re going to implement them. The more convincing the pitch, the more likely you’ll get the loan and better interest rates.
10. An LLC
Real estate investors should set up a Limited Liability Company (LLC). It’s a cheap and easy way to limit your risk and protect your personal assets. Most LLCs cost between $40 and $250 to create, depending on the LLC filing fees in your state.
Even the most well-thought-out plans can go sideways. You never know when a supply chain shortage, a pandemic, or a drastic market shift can totally derail your project. You don’t want to risk losing your shirt if they do.
Conclusion: The More Prepared You Are, the Better
Hard money loans don’t have the same government regulations conventional loans must abide by. While there are benefits, it also means you don’t have the same protections that traditional lenders enjoy.
Try to follow as many of the above requirements as possible. I’d argue that the most important ones are to find a quality hard money lender, to have a sizable down payment ready, to plan as much as possible, and to protect yourself by forming an LLC.
Before signing any agreement, you should have an attorney review your paperwork. Hard money lenders are private lenders and organizations, so they may not be as well-written as a traditional loan agreement. At the very least, the following should be included:
When you first get involved in real estate investments, it can be pretty scary. However, as you gain more experience and find an excellent hard money lender, you’ll eventually master the process, or at least as much as any of us can!Are you interested in learning more about specific types of hard money loans? Check out my posts on flip and fix loans and bridge loans.