Finding the perfect Hard Money Lender is just like finding the perfect diamond. When a couple is newly engaged everyone wants to see the ring. The blushing bride-to-be shows off her newly acquired diamond for everyone to see and the only thing anyone wants to know is how big the ring is. Yes, size matters, but size alone does not determine the value of the stone. The 4 Cs of diamonds are Carat, Cut, Color, and Clarity, which represent the most influential elements of the diamond’s beauty and quality— determining the value of each particular stone. Because every diamond is different from one another, diamond experts say to compare multiple diamonds using the 4 C’s to find the best diamond for your budget.
Much like evaluating the 4Cs in searching for a diamond, there are a number of factors a borrower should consider before choosing the right lender for their project. By applying the 4 C’s of Private Financing – Cost, Capital, Credibility and Certainty, you can compare multiple lenders and understand exactly what you are paying for and getting from your lender, allowing you to find the best lender for your project.
Similar to the question of carat size, borrowers seeking hard money loans oftentimes first ask lenders “What is your rate/points?” It is the most commonly asked question and sometimes the only determining factor of how borrowers qualify a lender. In reality, just like a diamond’s carat size, rate and point is not the only factor you should take into account when determining the true cost of a loan.
Cost is extremely important to investors because you want to pay the least amount of money possible for the loan. However, many lenders charge additional fees outside of rate/points options, making the loan more expensive than it appears to be. While rate and points have the most influence over the cost of the loan and its value to you, there are still other fees that can add up quickly that you must consider.
When comparing lenders, always ask for a breakdown of ALL ofthe costs and fees, not just rate/points. For example, some lenders advertise a low rate and points, but will tack on thousands of dollars for a document fee, processing fee, underwriting fee, appraisals/BPOs, application fee, and list goes on. Be sure to factor any and all fees charged by the lender into the overall cost.
The second C of private lending is Capital (also considered leverage). Basically, leverage refers to how big a loan the lender is willing to make. When you ask a lender what loan to value (LTV) they make, do you really know what the lenders are saying in their answers? What value are they referring to? The more important questions to ask are:
1). How big of a loan will the lender make at close towards the purchase price (this is known as the loan to as-is value)?
2). How big of a loan will the lender make towards the ARV (after-rehab value)? You should also ask if the lender will fund the difference between these two amounts as you complete the rehab, typically referred to as holdbacks.
Most lenders will not make a loan equal to 100 percent of the purchase price of a property. They want a borrower to have some skin in the game (cash equity) which is usually 10 percent or more of the purchase price. The lenders that offer more than 90 percent leverage at purchase are typically private individuals and will charge a significantly higher rate and points and/or will want a percentage of the profits, ultimately increasing your financing costs and reducing your profit. Many lenders will fund holdbacks during the rehab process or at the end when the rehab is complete, typically up to 100 percent of your rehab budget.
The point here is that every lender offers slightly different programs and you must compare all the components to find a lender that works best for you.
The third C stands for Credibility and is another important factor when searching for the right hard money loan. Regardless of how well-known a lending company is, or even its size, as an investor you should still do your due diligence on the lender’s credibility. The best way to do your homework is to ask other borrowers that have directly done business with the lenders you are looking into or simply ask the lender for references of previous clients. Finally, as most all research is started these days— Google it. Look up the lender online and check out its website, LinkedIn, Facebook, and any other information you may find online.
It is crucial to check on a lender’s credibility as private financing and hard money lending is not as heavily regulated as other lending spaces are. Unfortunately, not all businesses have the same level of integrity and professionalism, using tricks and tactics that can make receiving your actual funds difficult. Some lenders will re-trade, which means that they give you a quote but change the loan terms, rates, or even loan amount just before closing, backing you into a tight corner. Make sure that you do your due diligence and find a credible lender.
Finally, the fourth C represents Certainty – you want to look for the certainty that your lender has the experience, resources, and ability to close your deal.
Frequently, smaller lenders do not have enough capital to lend on your deal, so they will drag their feet until they are able to raise enough funds to close. Pay particular attention if the lender is planning to broker the loan to other individuals or companies that will ultimately be your lender. Always ask the lender where the funds are coming from and how much capital they are working with. It is ideal to find a lender that lends its own capital in addition to adequate working capital, offering you the certainty of closing and funding your loan in a timely manner.
Also, note that sometimes loan amounts are contingent upon valuation (appraisal or BPO), which means the initial loan amount is not a true commitment giving you little certainty. This can work for many investors, but there may be cases when valuations come in much lower than anticipated and your loan amount is below your comfortable leverage point. Some lenders will commit to a loan amount based on their own underwriting and may not require a formal valuation to be done.
Much like a couple must closely examine a diamond’s 4 Cs to find the right stone for their budget, a borrower should closely examine the 4 Cs of Private Lending to find the right loan and lender that suits their real estate investment needs.