I’m Corey Dutton and I’m a private money lender. Today I’m going to give you some “Hard Money 101.”
This topic is about, 7 Ways to Get Yourself in Trouble With a Hard Money Loan.
Hard money loans can be great! They can make real estate investors a ton of money. But if you’re not using these loans properly, they can get you into a lot of trouble.
Let’s talk about 7 ways that hard money loans can get you into trouble:
#1: The lender not funding and losing your earnest money:
This a huge way that you can get into trouble. You go to a lender and you’re depending on this hard money lender to fund your loan by your deadline or you’re going to lose your earnest money. The lender drags its feet, wastes a ton of time, and then declines your loan. If this is a purchase, this means that you’re going to lose your earnest money. That’s a huge risk. So make sure you’re aware of that when you engage a hard money lender on a purchase transaction that you need to close quickly.
#2: Paying Upfront Fees to a Hard Money Lender:
Paying upfront fees such as appraisal fees, inspection fees, attorney fees, and then never getting a loan? That’s a really fast way to get yourself into trouble with a hard money loan, particularly if you’re going out to multiple lenders trying to get a loan and each one of them wants an upfront fee. And then not one of the lenders actually funds the loan? This is a huge risk to watch out for when looking for hard money loans.
#3: Getting Involved With a Predatory Lender:
Let’s face it there are a lot of hard money lenders out there that just want to own your property. Their intent is that you will default on your loan, or that you will make some sort of mistake and fall behind on your payments, and then they’ll foreclose on your property. Their intent is that they’ll make all the profit on the property and not you!
There are a ton of private money lenders out there that are predatory. That’s one reason why you should be dealing with a professional or licensed private money lender if possible.
Do not mess with these random people out there who are not professional lenders that say to you, “Oh sure, I’ll lend you the money!” Because guess what? Those people are typically going to be the most predatory because they aren’t professional, legitimate private money lenders.
Let me give you 2 examples:
I know a borrower that was doing a flip. She had a loan with a hard money lender for 90 days. He didn’t give her any copies of the loan documents at closing.
And according to the loan documents, if she didn’t pay that loan off within 90 days, on day 91 she got slapped with a $15,000 fee!! So guess what? That lender just goes out and buys himself a new car on day 91. And then he tried to foreclose on her property after it was all repaired and ready for resale. This is a prime example of predatory lending at its finest! Watch out.
Let me give you another example. I had another borrower that borrowed money from an unlicensed private money lender that was in her real estate club. This was just some random business associate that the borrower met via the local real estate investment club. This private lender gave the borrower a hard money loan on a handshake for a 90-day loan.
The 90 days go by and this private lender slaps this borrower with an extension fee of 2 points a month, or 2 percentage points of the loan amount per month. On this loan, it was $5,000 a month she was paying in extension fees! The lesson learned is to be sure to read the fine print in your loan documents and watch out for predatory lenders like this! If they are not professional lenders or licensed, stay away! Sometimes you think you’ll get a better deal by getting a loan from a private individual, “friend,” or a business associate, but you won’t.
#4: Not Having a Solid Exit Plan to Pay the Loan Off in a Short Period of Time:
You’ve got to have multiple exit strategies on these loans because these are short-term loans with high-interest rates. Let’s say you don’t sell the property in the time that you think you’re going to sell it? Or, let’s say your exit strategy is to refinance the loan with another loan, and you can’t get approved for that loan?
Guess what? If you can’t pay the loan off in a short period of time you’re going to be paying an extremely high-interest rate for months, and months, and months. And eventually it’s going to catch up with you, eventually you’re going to fall behind on your payments, and eventually, that lender is going to foreclose on your property.
So make sure you have a solid exit plan and always know what you’re going to do if this happens, or that happens, in all different types of scenarios. Because you can’t just count on one exit strategy.
#5: Underestimating your Project Costs or Experiencing an Injury or Illness:
Let’s say you’re doing all of the work on the property yourself and it’s a rehab. If you hurt your back for example, and you’re the one that’s doing the work, how will you finish the project within your budget?
I’ve seen it happen. One of my borrowers was doing all the work himself. He didn’t have a contractor, he was in there doing all the sweat equity himself. Guess what? He hurt his back. He couldn’t go back on that job, and he couldn’t afford to hire a contractor to finish it, otherwise, he would go over budget. So he got himself into trouble quick!
I’ve also seen borrowers that underestimated their project costs from the start of the project, which is a very common thing that new real estate investors are going to do. And that’s a really quick way to get yourself into trouble with a hard money lender, because if the hard money lender is giving you rehab money and they’ve given you a certain amount for your rehab, and then you go over budget.
Where are you going to get the rest of the money to finish the project? Are you going to be able to go out and get another loan from somebody else? Probably not.
#6: Market Collapse:
If your plan is to buy a property and in 4 months, 6 months, after you fix it up and add a bunch of improvements you’re going to resell it. What happens if the market collapses in that time frame? That’s a huge way to get into trouble with a hard money lender because you are stuck paying on a high-interest rate loan. If you can’t sell the property for what you’ve got into it because the market collapses or someone lists a better house for less money on the same street? What will you do?
#7: Getting into Too Much Debt:
This is called “over-leveraging” yourself. Leverage is debt. So if you’re over-leveraged, it means you have too much debt.
I’ve seen borrowers take out a first, second, and a third mortgage on a property to get it purchased and rehabbed. And then guess what? They’re paying the interest payments, interest payments are high, beginning to stack up, and then all of a sudden before they know it, they owe more money than the property is worth!!
With the interest and the fees you’ve paid to hard money lenders, there’s probably not going to be a lot of profit left there for you if you get into too much debt.
In conclusion, make sure you know what you’re getting yourself into when you take out a hard money loan. Please spread the word and share this video with someone that you know that may be out there looking for a hard money loan for the first time. Or someone that you know that maybe doesn’t understand all of these risks because it’s important to know what you’re getting yourself into with a hard money loan.
Like I said before, you can make a ton of money using hard money loans in real estate, but you can also get yourself into a lot of trouble if you don’t understand all of the risks.
If you have any questions or comments about this post or any of the risks I’ve discussed here, please leave your comments in the comments section below.