What to Know About Hard Money Loans for a Fix and Flip

Guest Post by Grant McDonald

According to a Gallup poll released in 2020, the majority of Americans believe real estate is the best long-term investment option among a variety of investment possibilities. Real estate takes the top spot on the list of favored long-term investments with 35%, followed by equities (21%), gold (16%), and savings accounts (17%). At 8%, bonds are the least favored long-term investment.

If you know how to do it correctly, flipping houses may be a profitable real estate investment option. But, of course, securing funding for a flip is critical since you can't perform repairs and flips without money, right? Hard money loans are a terrific strategy for real estate investors to generate money and create wealth quickly.

If you're thinking about using hard money loans for your next fix and flip, here's what you should know.

Why hard money loans are a good option 

A hard money loan, also known as a fix and flip loan, can help a beginner flipper working on one flip and a seasoned rehabber working on several flips simultaneously to succeed. Many other types of property investment projects can be financed using hard money loans.

“There are obviously a lot of expenditures associated with flipping a house for the resale market: borrowers must take into account the purchase price of the property, the cost of renovations, and the possibility of unexpected expenses,” says Joshua Blackburn of Evolving Home.

Using hard money to scale your investment properties is a particularly effective strategy, as it allows you to take on projects progressively with little money down. Hard money loans also reduce the amount of money a flipper has to invest in a home during the renovation process directly.

What to do before applying for a hard money loan

If you want to get your hard money fix and flip loan approved quickly, it’s important to be prepared. 

That involves knowing your private lender, how much money they typically lend, the interest rate they charge, and any other conditions they may impose. You'll also need a workable budget, as well as a complete accounting of your cash on hand and alternative financing choices.

After you've nailed down these elements, you'll be prepared to look at property leads with new eyes and a strategy in mind.

In addition, look for homes that are priced just around your lender's average hard money loan amount, ensuring that you're bringing them bargains that they can actually accept. 

When you've discovered a home that meets your criteria, you'll need to do the following:

Perform a property appraisal

Performing a property appraisal can include some of the following steps:

• Calculate the cost of renovations.
• Calculate the item's worth after it has been repaired (ARV).
• Before financing charges, calculate your estimated profit margin from the sale of the renovated property.
• Prepare a deal information packet with all of the information mentioned above for possible lenders (if necessary).
• Calculate how much a hard money loan will cost.
• After financing charges, calculate your estimated profit margin from the sale.

When you're getting ready to apply for a hard money loan, you don’t want to mess up the property appraisal.

“Lenders are not likely to lend you the money if you're willing to pay the asking price for an inflated property since the asset they'll be receiving as collateral isn't likely to be worth as much as you need it to be,” says Isaac Zisckind, Senior Partner and Real Estate Lawyer, Diamond & Diamond Lawyers. 

If you're good at spotting undervalued homes, on the other hand, you might be able to acquire better interest rates from hard money lenders because your prospects of generating a profit are higher.

Last but not least, if you're going to a foreclosure auction to look for homes, you'll need to be prepared to move quickly and have a strong idea of how much money you can really acquire when bidding. So, before applying for a hard money fix and flip loan, always prepare ahead and plan attentively.

Create a budget

Your hard money fix and flip loan will most likely be the focus of your financing strategy, and it will have a significant impact on whether the project succeeds or fails. If you want to consistently generate a profit, you must thoroughly understand all potential costs. It'll also help you understand how much time you have to renovate and resell your home.

After you've closed your first successful hard-money sale, the entire preparation process will become second nature to you. It is strongly recommended to create a budget and deal evaluation spreadsheet in the months leading up to your first deal to keep track of your estimated expenditures and margins. Everything becomes much clearer when you can view all of the facts on one page.

How to apply for a hard money loan

Now that you've completed the preparation phase, it's time to move on to the application procedure. Thankfully, applying for a hard money loan is a lot easier than locating profitable homes and determining whether or not they're worth remodeling.

The application process typically includes the following steps:

• Place a contract on a property.
• Consult a loan officer.
• Fill out the application for a loan.
• Wait for the application to be reviewed by the underwriter and loan officer.
• Obtain a property appraisal from a third party (if necessary).

Please provide any supporting paperwork for the property or your company (if necessary).

In any case, you should be prepared to show the lender proof of income. While you may not need to explain your valuation or the predicted costs and profits all of the time, your lender will almost certainly be doing their own calculations for every aspect of the transaction — except for how much profit you'll make after it's all said and done, of course.

You might even ask to compare notes if you're working with a hard money lender with whom you have a good working connection.

How to get pre-qualified for a hard money loan

It's critical to have a hard money fix and flip loan lender who moves at your pace, especially if you plan on performing a number of deals at once.

Getting pre-qualified by a lender can help you cut down on wasted time and increase your transaction flow significantly. However, the requirements for becoming pre-qualified vary greatly from lender to lender, and getting your foot in the door with the major national lenders can be difficult.

Pros and cons of hard money loans

There are several compelling reasons to seek a hard money loan rather than a traditional bank loan, but also several reasons not to. 

Pros

The following are the pros that hard money loans provide to real estate investors:

• Flexible terms — Because private financiers provide hard money loans, investors may have more flexibility in negotiating loan terms. During the underwriting process, users may be able to modify the repayment plan to their needs and have certain fees, like the origination fee, decreased or removed.
• Convenience — Applying for a mortgage takes time, especially with the new mortgage lending standards imposed as the Dodd-Frank Act. Clearing a loan might take months, putting investors at the chance of losing out on a specific investment estate. A hard money loan can provide funds in as little as a few weeks. This is critical if you're sponsoring a big development venture and can't afford to miss the deadline.
• Collateral — With a hard money loan, the asset itself is typically used as collateral. Lenders may, however, give investors some freedom in this area. Some lenders, for example, may allow you to use personal property to protect the loan, like a retirement account or a unit you own.

Cons

Hard money loans aren't always the best option for funding. There are two major disadvantages to consider:

• Cost — Although hard money loans are easy, they come at a cost to investors. The rate of interest might be up to ten percentage points more than a traditional loan. Investors will likely pay more in service charges, loan service fees, and closing charges.
• Shorter repayment period — The goal of a hard money loan is for an investor to be able to get a property ready to sell as soon as feasible. As a result, compared to regular mortgage loans, these loans have substantially shorter repayment schedules. It's critical to have a clear understanding of when the property will become lucrative when picking a hard money lender to assure that you'll be able to repay the loan on time.

The bottom line

Aside from going via institutional lenders, hard money is a faster way to secure a real estate loan. Private people or investors that have hired hard money loan organizations to manage their investment portfolios provide funds for hard money loans.

A hard money loan is an excellent option when banks have turned down a loan application or when speed is of the essence.

By thoroughly knowing your lender's terms and costs, you can protect yourself from all of the problems we've discussed. Prepare a solid exit strategy and ensure that you can make timely payments in order to establish a long-term connection with a lender.

Grant McDonald has more than three decades of experience in the real estate industry and more than a decade in the real estate finance space. He is currently Vice President - Corporate Development at 14th Street Capital - America’s premier hard money lenders for real estate investors.