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Explaining Hard Money Loans - Real Estate Investment Tips

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Published on Jul 4, 2013

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One type of a loan you can get as a buyer or property owner is called a Hard Money Loan. A hard money loan is basically an expensive, short term loan used when typical lower rate financing isn't available. As of this time, a typical hard money loan will run you about 10-15% or more and will cost anywhere from 4-7 points. Points are an upfront fee of the loan amount. Also, unlike typical financing Hard Money loans are very short term -- usually under two years. Let's look at how much larger a payment would be using a hard money loan vs. typical commercial financing.

As of today a typical commercial loan in the amount of $1m will run you about 6% and about 1.5 points, whereas a hard money loan will run you about 10% and about 5 points. A typical loan will cost about $72k per year, or just shy of $6000/month. The hard money loan in this example will cost about $105k/year, or $8775 per month. So the question you're wondering is "why even bother with a hard money loan if it's so much more expensive?" Well, I'm about to show you one perfect example.

Presume we are looking at a $1M investment property. As we run numbers we realize this would be an absolutely GREAT investment. After doing a little bit more homework we find out the ENTIRE building is empty! But even though this property isn't bringing in any income NOW, with a little work and proper management it WILL make a great investment. The problem is you only have about $500k. Remember from my "Commercial Loan Process" video that a loan for an investment property basically needs to pay for itself and then some. Knowing this, we obviously can't go to any bank and get the other $500k since there's no income coming in, and you don't know anyone that has that kind of money that is willing to lend to you -- be it family, friends, whatever...who can you turn to? That's when you have to turn to a small group of individuals with tons of money that want to make a fast buck. Even though it's a little biased, I always tell my clients to compare these hard money lenders to someone we're all familiar with. Uncle Scrooge! We all know Uncle Scrooge right?

He's that distant relative of ours that has money to spare, but he's only willing to share if you cut him in on the deal and pay him a good profit...So you tell your Uncle Scrooge about this amazing property. It can do really well, but you're short half of the money. He tells you "No prooooblem...I'll let you borrow the $500k that you need. I mean you're putting half down too right? Buuuut...I want $30k up front to do the loan. And I want 12% interest...and I want ALL my money back in 2 years. If we have a deal I'll look over a few things and send you the money in about 2 weeks."

You realize Uncle Scrooge is really a penny pincher!! Let's see...a normal bank would charge us about $7500 to do the loan, not $30k...they'd also do the loan for about 5 or 6%, not 12...and two years!? Man...that's a really short amount of time to buy the place, get it stable with tenants and then refinance or sell it, but at least we can get the funds from Uncle Scrooge in just 2 weeks! After running some numbers, you come to the conclusion that this property is SOOO good, that even WITH this really high loan, you'd be able to make a decent return. In fact, the more you analyze this property the more confident you feel about your expected return after you get tenants and refinance the place.

THIS is why you do a hard money loan when you are out of options. Because even though Uncle Scrooge wants to make a really good profit in a really short timeframe, YOU can make an even BETTER profit on something that you weren't able to even afford without him. This is also a good thing if you already own a property outright -if you need equity fast and you don't have time to do a full refinance. If regular financing is out of the picture, if you can't pay cash but you're confident enough on the potential of a particular income property, you contact your lender and find the hard money lenders. You don't want to make this your first choice, but you do want to be able to have a fallback option as a last case scenario instead of passing up a great buy...now that's good to know.

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