I recently did a survey of all of the hard / private money lenders I know in the industry. I also posted the survey on LinkedIn to get answers from the hard/private money lenders I don’t know. The question I asked these lenders was pretty simple:
“What are the top 3 reasons you decline a real estate deal when the numbers make sense?”
Although I received a lot of different answers to this question, there were 3 top reasons that kept appearing from the majority of the hard money / private money lenders I surveyed.
1. Neighborhood: The property is located in a high crime or extremely distressed area. Sometimes this is where the good rehab properties are found, but if a lender is afraid to get out of his car without a gun when he/she does the site inspection, you most likely won’t get a hard money loan on it.
2. Location: The property is located outside of a major metropolitan area in a rural location where there are no sold comparables within 2 miles of the subject property. Hard money and private money lenders prefer to lend in major metropolitan areas over rural locations. Although a real estate deal in a rural area may look good on paper, if there aren’t sold comps nearby to support value, a hard money lender may turn it down. Also, smaller market, smaller pool of buyers. There are exceptions of course.
3. Borrower’s Cash Reserves: Particularly on a rehab loan, a borrower who seems to be grossly undercapitalized is a sure decline. Lenders want to make sure a borrower can cover any shortages in construction, or in case of a low appraisal for the refinance.
If you are a borrower who has been turned down for a hard money loan on a deal that penciled on paper, please share your experience. If you are a hard money lender reading this, please share your own top reasons for declining a real estate loan where the numbers made sense.
One of the real estate investors we fund loans for came to me with an idea last week. His grandmother has a free and clear mansion in the Hamptons, NY. She offered to get a cash out refinance loan against the property and then use the cash to invest in real estate. She wants to be the cash partner, and wants her grandson, (my client) to be the sweat equity partner. But….does this sound like a good idea?
This real estate investor carefully weighed in all the costs involved in using his grandmother’s money on real estate deals. He uses hard money loans for financing the bulk of the purchases and uses his own money for down payment. Whatever the cost of the loans, he just takes that out of the back-end equity in the deal.
He calculated the numbers based on his grandmother’s cut of the equity, versus the hard money lender’s cut of the equity. Not only would it be more expensive to use his grandmother’s money, he decided that the mental stress of using her money just made the overall costs too high. To use her money on a deal, Grandma wants 65% of the back-end equity. In other words, grandma wants 65% of his profits! Using a hard money loan is definitely a cheaper option for this real estate investor. He pays us interest on the loan and a loan fee for giving him the loan. And we don’t take a cut of his equity like Grandma.
Money from family and friends may have a lower cost of capital than using a private money lender, but it’s important to consider the full costs of involving them in your deals. Whenever you involve a family member or friend in business, there are always intangible costs to consider. Sometimes it’s just cheaper and less stressful to use private or hard money loans to purchase real estate investments rather than involving family or friends.
Any thoughts on this topic? Please share your comments below.
When a bridge loan serves as a “bridge” from one stage to the next stage of financing, an example:
An LLC wishes to purchase an Assisted Living / Senior Housing Facility. The property is eligible for FHA Financing, but the approval process takes nearly a year. A bridge loan would be used in the first stage of financing, in the acquisition of the Assisted Living Center. The FHA financing will refinance the bridge loan within 8-9 months.
A bridge loan is also called a hard money loan. It can be used to take advantage of an opportunity quickly or provided under other, non-conventional lending circumstances. An example:
In the case of a property acquisition, a bridge loan can allow a real estate investor to buy a property at a low price, and then resell quickly at a higher price.
The interest rates charged by a bridge loan lender are much higher than interest rates found at a bank. Most bridge loans are of a short-term nature, typically from 2 to 3 years. There are some bridge loan lenders that offer 5 year terms.
Bridge loans require more money down on a purchase than a bank loan. On commercial purchases, bridge loans are typically 65-75% of the purchase price max. But when compared with new depository requirements of banks, the down payment is nearly equivalent when comparing a bridge lender with a bank lender.
Do you have questions about our bridge loans? Please click here.
A private money or hard money loan has much lighter documentation than a bank loan. Depending on the hard money lender, some will require more items to close than others. Below is a list of the most common documents required to close a hard money loan:
- Purchase contract if it’s a purchase loan. If it’s a refinance loan, you’ll need a payoff statement from the existing lender.
- Preliminary Title Report to show clear Title to the property. The designated title company for the loan will provide this.
- 2 Forms of Identification if the borrower is an individual. If the borrower is a business entity, corporate documents or operating agreement. A Certificate of Good Standing with the Secretary of the State for the entity can also be required, if borrowing as a business entity.
- Proof of funds statement if it’s a purchase loan. The private money lender wants to see that the borrower has enough funds for the down payment. A recent bank statement or other account statement(s) is usually sufficient.
- Proof of Insurance for property being purchased or refinanced.
- Optional Items can include a loan application, credit report, copy of lease and/or rent roll if a rental property.
Because each hard money lender has it’s own list of documents required to close a loan, please verify in advance of being pre-approved for the loan. This will save you time and help you get your hard money loan closed more quickly.