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How a Hard Money Loan Works

How does a typical money loan in a house flipping deal work? The first thing to understand is that there really is no such thing as a typical hard money loan and every hard money lender looks at things a little differently.  They each have their own underwriting criteria, borrower requirements, and loan structures.  However, most hard money lenders size their loans based on a percentage of the borrower’s After Repair Value (ARV), an independent appraiser’s ARV, in-house ARV, percentage of the purchase price, percentage of As-Is Value, percentage of total costs, and/or any combination thereof.

 

This being said, we can make some generalizations.  For residential flip loans, most hard money lenders will provide roughly 80%+ of the purchase price or 60-65%+ of the ARV of the house.  So, by way of example, if you are buying a home for $250k, spending $50k on rehab, and expect to sell it for $375k, you will probably see loan quotes anywhere from $200k-$250k.  Again, this is a generalization, and some lenders will do a loan outside of this range.  However, note that this example assumes your lender agrees with your $250k purchase price and/or your $375k ARV.

 

In addition to the amount a hard money lender funds at the initial purchase, some may reserve a portion of the loan funds for future advances.  This is what is commonly referred to as a “holdback”.  The holdback may be funded at certain milestones during the rehab, or in a single amount at the end when the rehab is complete.  The holdback can provide a flipper with cash flow sooner by allowing them to pull some of their equity out of the house, prior to the eventual sale.  It’s important to know that many hard money lenders charge interest on the entire loan amount, including the holdback, starting from the initial funding.

For loan pricing, most lenders charge between 9%-12% interest per year, plus a loan fee of 2%-4%, for up to a 12-month loan term.  However, be aware that in addition to quoted loan origination fees, some hard money lenders also charge fees for credit checks, appraisals, loan documentation, inspections, recordings, reconveyances, etc. (in industry jargon, these are typically called “junk” fees).

 

A tip when comparing loans: do not just look at the rate and loan fee. If the lender has junk fees, they can have a substantial impact on the true cost of the financing. When comparing loan proposals, be sure to look at ALL of the costs of the loan and compare them on an “apples to apples” basis.  Just because a lender says they’ll do a “9% rate and a 2% fee”, if the lender is also charging you thousands of dollars junk fees, then that rate and fee quote is misleading with respect to the true cost of the loan.

 

As you can see, there can be a pretty wide range in loan sizes and loan costs between different lenders. However, finding a good lender is more than just who has the lowest rate and fee. It is just as important (perhaps even more so) to be sure you know who is lending you money, know what they stand for, and to be sure they will deliver and do what they say.

 

For more information on How to Choose the Right Hard Money Lender Click Here.

 

 

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