A hard money loan is an excellent way for real estate investors to finance an investment regardless of whether the plan is to build or flip a property. Among the benefits of this type of loan are security, flexibility, and speed. To help you decide whether this type of loan is right for you, today, we’re taking a look at the requirements for a hard money loan.
What Are the Requirements for a Hard Money Loan?
One of the most important things you need to do if you want to get a hard money loan is to save up a significant amount of cash. You must be able to pay both a down payment and fees. The down payment required on a hard money loan is simple to calculate, but you should not be surprised if you arrive at a high number. Hard money loans are riskier for lenders because only the property backs the loan.
To calculate the down payment you will require, you need to know three numbers. The first number you need to determine is the ARV (after repair value). You also need to know the purchase price and your budget for repairing or building the property. The calculation is as follows: down payment = ARV*0.7 – purchase price – budget.
Pretend, for a moment, that you discover a property that you think you can sell for $250,000 after you fix it up (after repair value). It is currently on the market for $100,000 (purchase price). You estimate between labor and materials you will need $50,000 (budget) to make the property worth $250,000.
Multiplying the ARV of $250,000 by 70% gives you $175,000, but this isn’t your required down payment. You need to get a net of $175,000 less the $100,000 purchase price and $50,000 budget. The down payment in this example is $25,000 (10%), half of the traditional down payment required for a conventional mortgage (20%). However, you may find that your required down payment is over 20%. Also, don’t forget you will need to pay such expenses as:
- Property insurance
- Closing costs
- Underwriting expenses
- Loan origination fees
Create an LLC
You also will need to create an LLC (limited liability corporation) if you want to get a hard money loan. It is extraordinarily rare that real estate investments, especially when the goal is to flip a property, go according to plan. To mitigate your risk of losing personal assets if things go south, you need to set up an LLC or S-Corp. To create an LLC in Pennsylvania, you will need to:
- Name your limited liability corporation
- Choose a registered office
- File a certificate of organization
- Create an operating agreement
- Get an employer identification number
Find a Reputable Hard Money Lender
You also need to find a reputable lender if you want to get a hard money loan. It is vital that you understand banks and similar financial institutions that are heavily regulated do not offer hard money loans. Make sure you strongly consider the potential lender’s speed, affordability, and reputation.
Prepare Proof of Income
You must be able to provide proof of your income to qualify for a hard money loan. There is a lot less paperwork required to get approved for a hard money loan. This is, in part, because the loan is secured by neither your credit nor your personal assets. That said, proof of income is one of the required documents you will need to prepare because we need to know that you are capable of making your monthly payments.
There are a number of document types that you can use to prove your income. Most people can submit a W-2 and pay stubs. However, if real estate investment is your only job or you are otherwise self-employed, there are other documents that will suffice. For example, bank statements and tax returns can go a long way in proving that you can make your interest payments every month.
Something to Consider
If you are self-employed, your tax return may not paint the brightest picture. Don’t worry. We understand that self-employed individuals often strive to minimize their tax liability to the greatest extent possible. On paper (your federal tax return), you may not be making a lot of net profit. That’s where your bank statements come in handy. Your bank statements will show us how much income you’re bringing in every month.
They will also show us what your monthly expenses are. From that information, we can determine whether you are bringing in more money than you are spending every month and can afford your monthly interest payments. Another thing you should consider is that you shouldn’t apply for a hard money loan until you are ready to start your project. It is in your best interest to submit your bank statements when you have enough money to cover your loan costs.
Prepare Your Repayment Strategy
It is also essential that you prepare your repayment strategy. Most of the time, people buying a house take out a loan with a term of 10, 15, or 30 years. Hard money loan terms are usually for 12 months. However, there are cases in which a two-year or three-year loan term will be accepted. Regardless of your loan term, though, you need to make sure you have an exit strategy before you even apply for the loan.
Other FAQs Answered
Is a Hard Money Loan Right for Me?
There is a pretty good chance that a hard money loan is appropriate for you if you need funds very quickly. However, they are not appropriate for everyone. They are a tool for real estate investors who want to flip a property or finance the construction of a building.
If you want a short-term loan because you need to buy a new home and your current home hasn’t sold yet, a bridge loan is more appropriate for you. Also, you should know that some lenders will not provide a hard money loan to someone without new construction experience.
What Questions Should I Ask Before Applying for a Hard Money Loan?
Before you apply for a hard money loan, it’s essential that you know exactly what you’re getting into. Make sure you know what documents are required for you to get the lone, and ask whether an appraisal is required. You should also know when interest is collected and what happens if you need an extension. If you’re looking to finance a fix-and-flip project, you should also get clarification on the construction draw process.
Among the requirements for a hard money loan are saving up the cash necessary for a downpayment and fees, creating an LLC, and finding a reputable lender. It is also important that you prepare proof of your income and your repayment strategy in case your plan does not come to fruition as you expect it to. Contact us today at Turning Point Lending if you need to apply for a hard money loan from a trustworthy lender with years of underwriting experience.