Hard Money Lending
Pete Aldrich of Sawyer Street Capital, LLC, is a healthcare executive turned Real Estate Investor, Developer, and Private Lender. He was our guest speaker and did a great job breaking down hard money lending, pros/cons, and major red flags.
Pete is focused on long term buy and hold. He is an investor first, then lender, with a goal of building passive income. He got into lending because of a lack of hard money lending resources. Once he realized the power of private lending, he realized he could significantly increase his holdings while using the same pool of money over and over. He is not actively looking for new investments but will take the time to review what comes his way, so if you are looking for a hard money lender, Pete is an excellent resource.
There are three levels to “private” lending:
Friends & family lending. This is typically a handshake deal and may or may not include formal contracts.
Private lending. Typically this comes from someone directly (not as many degrees of separation), is more informal than hard money lending, and comes with a lower interest rate.
Typically some sort of personal connection.
Hard money lending. An investor has put capital into an entity, which is then lent out. Hard money lenders make their money on origination fees, extension fees, points, and default.
For example, the entity may charge 15% + 4 points, take 2 points for themselves, then pay out 14% and 2 points to the investor.
More disconnected than private lending and is set up to be more institutional.
What is typical of a Hard Money Loan?
It is almost always short term, likely 24 months or less
It will always come with a higher interest rate than what you would see at a bank.
Typically it is an interest only loan during the life of the loan, with full payment due at the end.
The points are almost always paid up front to the lender.
The loan is paid out in installments. For example, if you are doing a rehab project, half may be paid up front with a plan for additional draws based on specific milestones being met during the project.
The loan is almost always granted to an entity, not an individual.
Note: rarely are loans given for primary residence or something owner occupied. This is to ensure in the event of default, the process is not drawn out due to occupancy.
How do people most frequently get into trouble with hard money loans:
Underestimating progress and the time it will take to complete a project.
What is the end game with a hard money loan?
Typically (and hopefully!), a borrower has an exit strategy, meaning they have a plan to pay back the lender in a short period of time. This is frequently through a cash out refi, where they pay the balance of the loan to the lender, recoup their capital, and refi into a lower interest rate loan with a traditional bank.
Why get a hard money loan instead of going to a traditional bank?
More often than not, borrowers could also qualify from a bank but choose not to take the bank loan because they are looking for a short term loan that allows for equity creation, which can be captured through a cash out refi at the end. Many hard money loans are also “flips” where they will rehab the property, then sell and do not want the hassle of bank involvement.
Additionally, banks will only lend typically 75-80% of the purchase price on an investment, requiring a borrower to have that cash down plus the cash needed to rehab the project. With hard money lending, it’s possible to keep more cash available and also recoup the capital spent, allowing it to be deployed elsewhere. It allows for scale and growth.
Many borrowers may not qualify for traditional lending. For example, they are self employed without 2 years of tax returns. Conversely, the property itself may not qualify with a traditional loan; if systems are missing or it is in a state of disrepair it can be a challenge to get a traditional Fannie/Freddie (or even portfolio loan) to underwrite it. Finally, Hard money loans are quicker and have less red tape; a great option for someone who does not want to deal with the complexity of a traditional bank.
Tips for starting out as a hard money lender:
Pay a lawyer and get your templates and systems done up front.
Always ask the borrower the end game and understand their plan thoroughly.
Understand the property - even visit it if necessary.
Always take a first mortgage, never accept a second mortgage.
Ways to raise capital to get into being a lender:
Using bonuses from a W2 job
Converting retirement accounts into 401k attached to a real estate business
Self directed IRAs
Loans against retirement accounts
HELOCs from other properties
Margin loans from investment accounts
Tips for a borrower:
Come prepared. It’s not about the experience, but about the presentation given. Have a reasonable project plan, with realistic time frames and budgets. Demonstrate to the lender that you know what you are doing and can deliver on your commitment.
Have cash available to contribute. Most hard money lenders want to see a borrower with some skin in the game.
Don’t take a loan less than 9 months, as you will get charged points to extend the loan and, with construction delays, etc. more than 9 months is likely to complete a project.
Don’t allow a pre-payment penalty.
Negotiate!
Ask around until you find someone who has dealt with the lender you are talking to. Vet them thoroughly.
Red flags:
Application fees
Forcing timelines below 6 months
Personality differences (trust your gut!)
Understand what you are committing to, especially the time frames.
Questions:
What are typical rates? 12-14% with 2-4 points.
Are rates negotiable? Yes. There is a lot of “rinse and repeat” because many borrowers don’t understand what they are signing. Private lending is very much a back and forth between borrower and lender.
As always, none of this is advice or guaranteed to be correct. Consult your trusted professionals about your specific situation.