The Benefits and Risks of Hard Money Lending
Whenever someone discusses real estate investment, people tend to assume that it concerns of the common forms of direct investment in real estate like purchasing a property and selling it off after developing it, short-term fix and flip operations, or even deriving income from rentals. Even though these options are the most popular, none of them may be suitable for you unless you have experience and skill in spotting real estate opportunities, purchasing them, and using them to generate income. However, if you are an investor looking to make the available money work harder or diversify your investment portfolio, you can consider becoming a hard money lender.
What Is a Hard Money Loan ?
Hard money loans are simply non-institutional short-term bridge loans used for financing real estate transactions. The loan is typically extended based on the collateral value of the property being purchased by the borrower and not on his creditworthiness that is integral to conventional loans. Conventional financial institutions such as banks and credit unions do not extend hard money loans and it is normally the domain of private individuals or companies that are comfortable with potentially high-risk transactions.
What Are Hard Money Loans Used For ?
The objective of a borrower of a hard money loan is normally to buy an undervalued property, fix it quickly, and sell it off for a handsome profit. However, some leans may also be given for making a new construction, which can be sold off either wholesale or retail. In both the scenarios time is of the essence since the borrower wants to complete the project quickly and exit to make a profit. While some hard money loans can be made on an overnight basis, most of the loans are extended for short terms of six to 12 months. The typical cost of a hard money loan is far higher than a normal bank loan of a government program loan since it involves high risk. Normally, the lender does not bother with a risk evaluation and credit assessment of the borrower like studying income statements, project details, and credit scores but rather restricts him to make sure that the collateral offered is adequate.
The Benefits of Being a Hard Money Lender
The first and foremost benefit of hard money lending is that the return on investment is very high and can beat traditional investment opportunities like stocks, bonds, or bank deposits. Typically, hard money lenders like Liberty Lending do not lend beyond a loan-to-value ratio of 65-70%, which can be considered pretty conservative. Hard money lending is perfect for individuals with expertise in money matters yet who want to take advantage of the boom in real estate markets without getting their hands dirty. Hard moneylenders only need to understand how the real estate market works and not get involved in the actual work needed to renovate or construct the property, which builders and developers are better suited.
The Risks Associated With Hard Money Lending
To become a hard money lender, you need to have access to a lot of funds. If you do not have the money personally, you will need to either tap cheap sources of funds or get together a group of high net worth individuals to set up a fund that you can lend to borrowers. You will need to have adequate income from interest to cover the expenses of handling the loan accounts as well as the foreclosure proceedings for the occasional default. Lenders also need to acknowledge that the return on investment will be significantly lower than if you were to undertake the project directly. If a project delivers more than the expected profits due to any reason, no part of the windfall accrues to the lender; everything is to the credit of the borrower because he is the person who took on the equity risk. The hard money lending industry is completely unregulated and lacks any kind of standardization, which can be both a boon and a risk. However, the lack of standardization means that lenders are pretty much free to evaluate projects as they like and end up exposing themselves to more risk than they perhaps intended.
Regulations Impacting Hard Money Lending
Even though most people, including hard money lenders, believe that the practice is not subject to regulation, there is potential for violation of usury laws that most states have in place. While the application of these laws varies with the type of lender, borrower, and loan amount, states like California have a cap on interest rates. Even though the limits are subject to exceptions depending on the type of lender and the type of the property, it gives defaulting borrowers a plan to challenge the loan contract on legal grounds. Violation of usury laws can have serious implications like the interest obligation of the borrower being invalidated, a penalty of two or three times the interest paid, loan nullification, and very hefty fines. Lenders may even be imposed criminal penalties in states like Florida. With this kind of a legal environment, lenders can face false legal claims to thwart foreclosure proceedings. Lenders should be aware of the usury laws in their states in which they do business and operate within the limits because failure to do so could potentially invite expensive lawsuits and bad publicity.
Hard money lenders tend to be freewheeling and do pretty much what they like for processing loan applications. Since they have the property being financed as collateral, they tend to skip most of the documentation and verification procedures. Not following the TILA-RESPA Integrated Disclosure (TRID) rules can be then interpreted as predatory lending practice if a lawsuit is instituted against them. According to https://www.forbes.com, some states require lenders to possess a license if the loans are secured with residential property.
Hard money lending, like any other business activity, has its share of pros and cons. It is advisable that people who want to enter this sector to evaluate the benefits and risks thoroughly so that they are well aware of what it entails. It is important to have goals and objectives clearly defined and also to know your strengths and weaknesses so that you can operate at your maximum potential.