Guide to Hard Money Lending in California
In the state of California, hard money loans have become increasingly popular over the years—especially in the industry of real estate. After all, California currently boasts one of the most liquid real estate markets in the entire country, so there is a lot of competition among lenders. This trend doesn’t show signs of slowing down any time soon, especially when you consider that the real estate market in California is only growing and becoming more fruitful, especially for real estate investors.
As a result of high competition in the lending market, many borrowers are now turning to hard money loans (and more lenders are offering them) as a means of financing real estate purchases. This is especially true in fix-and-flip situations and other real estate investments. By having a better understanding of how hard money lending works and what sets it apart from traditional real estate lending, borrowers and lenders alike can make the right decisions to suit their needs
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Understanding Hard Money Loans
Hard money loans are most commonly utilized in real estate, though they refer to any loan that is secured by an asset. In the case of a real estate purchase, the asset is typically the property itself. In these situations, the real estate is essentially collateral in the event that the loan is not paid back. This is much different from an unsecured loan, where no collateral is put forth in exchange for funding.
Typically, when a hard money loan is issued, the loan term is 12 months, so these loans also tend to be shorter-term than many other real estate financing options available. This works to the advantage of both borrowers and sellers because it ensures lenders receive prompt repayment of their funds, and it reduces the total amount of interest paid by the borrower. Interest rates for hard money loans can vary greatly from one lender to the next, but they usually range between 7% and 14%. This interest is typically paid on a monthly basis, in addition to one balloon payment at the end of the 12-month term.
Another key characteristic of a hard money loan is that, because of the real estate collateral put forth, there is often less of a concern over a borrower’s credit score. Instead, lenders are more concerned about the value of the property itself. Still, lenders can decide whether they would like to run a credit check on borrowers and, if so, what types of requirements they will have in place for approval.
Hard Money Versus Soft Money: What’s the Difference?
It’s important to understand the difference between a soft money and hard money loan. A soft money loan in the real estate world would refer to a “traditional” mortgage, where borrowers need to prove that they have enough income, a decent credit score, and the right debt-to-income ratio in order to be approved for a loan. There is no collateral taken out to “secure” these loans, and so interest rates tend to be a bit lower. These loans are most often provided by larger banks and other financial institutions, and the repayment terms are usually much longer (sometimes up to 30 years, depending on the specific type of loan being taken out).
With a hard money loan, the focus is on the collateral being collected and less on the borrower’s credit or financial situation. Interest rates do tend to be higher, and repayment terms are shorter. On the other hand, financing through a hard money loan can often be completed in as little as a week or two. This is because most of these hard money loans are provided by private investors who have the funds ready to be transferred as soon as underwriting is complete. Furthermore, rather than even monthly payments, a hard money loan often requires a large balloon payment at the end of the term in addition to monthly interest payments instead.
Most often, hard money loans are issued to investors looking to complete a “fix and flip” on a real estate property. These projects involve making improvements on a property and re-selling for a profit. These flips are completed quickly so as to maximize profits and ensure money is paid back in a timely manner.
About Hard Money Lenders
As mentioned above, hard money lenders tend to be private investors rather than large banks or financial institutions. These are usually people who have a lot of money on-hand and available at any given time to make a hard money deal. Often times, these people also have a lot of experience in real estate so they know how to spot a good or bad deal when they see one. They’re also able to issue funding a lot more quickly than a traditional bank or other lender would, which is why they are often popular in real estate deals and fix-and-flips specifically.
Important Considerations for Borrowers
For those who are thinking about taking out a hard money loan for real estate in California, there are some important considerations to keep in mind throughout the process. Perhaps the most important is to ensure your personal guarantee on the loan, which is essentially your promise to the lender that you will pay the loan back on the terms upon which you have agreed. Keep in mind that if you don’t repay your loan according to those terms, you will likely default on it and may need to give up your personal assets or be brought to court.
This is another reason why taking the time to carefully research hard money lenders is so important; by doing so, you can make sure you’re entering into an agreement with a lender you can trust and who you can find agreeable terms to sign off on. Unfortunately, there are some dishonest lenders out there who will try to scam people out of their money, so it’s important to do your due diligence as a borrower to ensure you don’t end up in such a situation.
Getting Approved for a Hard Money Loan
No matter what type of hard money loan you’re interested in (commercial or residential), keep in mind that there’s a good chance you’ll end up having to submit to a credit check in order to be considered for the loan. However, unlike with a traditional loan, your credit score will likely not have a huge impact on your approval. What’s most important is to be able to demonstrate that you are able to repay the loan in a timely manner. With this in mind, a lender may not be too worried if you have a less-than-ideal credit score, so long as you don’t have bankruptcies or previous loan defaults on your record.
Hard money lenders have a difficult job of deciding which loans are worth funding and which are a risk to their wealth. While credit is one factor that should be considered when approached with a deal, ability to pay and other factors (like the value of the real estate itself) must also be kept in mind. From there, lenders can go into their deals with greater confidence that they’ll get paid back.