What to look for when speaking to hard money lenders

Question

I am speaking to quite a few HMLs for a new construction project. What are the thing to look for when vetting these HMLs? What are the ways in which a HML can turn out to be bad? Thanks.

Jeff S. · Answer

This is a popular question here, @Sanjiv Mehta so you might do a search.

The usual responses are to never pay up-front fees, make sure your lender is appropriately licensed in the state of the loan, and complies with all usury restrictions.  Read here for a more lengthy list:  Questions for Hard Money Lenders.

You don’t mention your state, but I suggest you stay away from strangers by borrowing locally and forming an eye-to-eye relationship with your lender.  You’ll never catch a break or receive an accommodation from someone you don’t know compared to someone you do.  Plus, this is a good way to know the person you’re dealing with is legit.  Real estate clubs are the best way to find a local lender, in my view.  Stay off the web.

A few questions rarely mentioned:

1) Ask where your lender gets their money.

Some loan off their balance sheet and are direct lenders (including syndicators).  In spite of what anyone says, those who loan their own money will always be the most critical of you and your deal.  This is in your interest.

Some lenders are brokers, arranging loans between parties.  While they might not have anything to lose, legally, brokers are fiduciaries and must at least look out for your best interest. Whether they always do or not is sometimes another story.

Some lenders are simply independent commissioned salespeople.  Though legal in many states, I’d be careful here.

2) Make sure your lender isn’t also in the construction or flipping business.

I hate to say it, but some borrowers I know that had issues last year during the pandemic were not treated very well by those lenders who were also their implicit competition.  No one thinks it can happen to them until their lender is motivated to force a deed-in-Lieu while salivating at your unfinished project.

Good luck to you, Sanjiv.

Jay Hinrichs · Answer

I would like to add.

Junk fee's  ask about those.. I saw one hud were the lender charged 800.00 for a tax service.. I was like what on a 12 month loan.

points are many times less than all the junk fees combined..

If this is true construction..  Interest payments on the commitment or as you draw.. this is HUGE.. we all charged on the commitment for years , but as the HML space got more competitive the bigger companies will only charge on funds that are drawn out.  If its a small rehab loan not a big deal but if its a 500k construction loan were your drawing say 100k a month for 5 months this makes a very big difference to you as the borrower..  Its just like my bank loans I only pay on drawn funds and in the rare instances we are at our limit with our banks and I take on a HML for construction I make sure its as stated.

Also cant emphasize enough what was said above about fake lenders with come on rates that will simply steal your money. Belly to Belly is a great way to go if you can do it.  Having that personal relationship can be critical.. For me having my core bank of 30 pus years got me through the GFC if I had been with some big bank that might have been a point cheaper I would have been toast.

Lastly if you have never built new construction you might find it difficult to find a lender.. and will need to bring in an experienced partner.

Michael Kinsella · Answer

@Sanjiv Mehta

Some of the items that you will want to evaluate when speaking with different lenders to see which one’s terms fit you best are,

• Loan amount: What will the loan amount be? Is it at a desirable level?
• LTC/LTV restrictions: "Loan-to-cost" and "Loan-to-value" restrictions will vary by lender, but lenders are generally within 5-10% of each other for a given product type. For example, a lender might offer you 85% LTC (loan-to-cost)/65% LTV (loan-to-value).
• Interest rate: What will you be paying to borrow the money? For the new construction loan you're describing, interest rates from hard money lenders generally range from the high single digits to the low/mid double digits.
• Points: What will the lender charge to originate the loan? If using a hard money lender, you can expect to pay at least a couple of origination points (% of the loan amount) at closing.
• Other fees: The cost of the appraisal, any underwriting fees, etc. These figures all contribute to your total cost of capital, and represent important points to consider as you go about obtaining a loan.
• Term length: How long is the loan? Do you have enough time built in for your new construction?
• Is interest charged on the full loan amount or just funded amounts?: This is a seemingly smaller point, but still one that's important to consider, particularly on a new construction project. If interest is charged on the full loan amount as opposed to just funded amounts, you could end up paying a significant amount for funds you aren't using immediately.
• Lender reputation: Is this lender trusted amongst investors? Have you spoken to other investors who have successfully employed your strategy and gotten positive feedback from them?
• Time to fund: How quickly does the lender move? What is their median time to fund?

The above list is not exhaustive, but serves as a reasonable starting point from which you can evaluate lenders. Asking these questions lets a lender know that you are serious and informed about the process, even if you are a new (or newer) investor.

Best,

Michael

Stephanie P. · Answer

When vetting hard money lenders, the first thing I would ask if there is an application fee or do I have to pay points up front.  If the answers to either of those two is a yes, then move on to the next one.

To offer a contrary opinion to some, not all brokers or internet based brokers in particular, are bad.  Checking reputations by doing your due diligence by following threads on Biggerpockets and other websites is really a smart way to start.  If someone answers questions in a thoughtful, respectful and intelligent manner with strong subject matter expertise, you can be somewhat assured that person or company takes their business, their reputation and career seriously and won't be a fly by night scam artist.  Licensing is not going to give you much of an answer because in this space, most states don't require licensing.  I will agree though, there is no substitute for meeting someone in person, but for the most part, unless they originate in a very small geographic area, you will not meet your broker or lender.   For example, we've originated millions of dollars of mortgages over the past 7 years and have met very few of our borrowers.  For that matter, we've never met any of the lenders we use everyday.  Many are on the west coast, Charlotte or Florida and we're in the DC metro area; in truth it's just not realistic.

Here are a couple of things to think about:

• The rule of thumb for most hard money lenders is they want the borrower to come up with at least 10% of the purchase price (depending on your experience, that number is more realistically in the 20% down area) with 10% of the rehab budget in reserves.  Remember, you're going to complete the work per the draw schedule and then get reimbursed (not many lenders front the rehab money although some do).
• Your numbers have to be tight, meaning you have to buy the property right, understand your construction and carrying costs and they have to correspond to the market.  I think the best reason to use a hard money lender is they understand risk and won't let you risk their money on a stupid project.  Buying a 100K house in a 200K neighborhood might sound great and get you excited, but having to put another 100K into it to be able to sell it won't happen with a good hard money lender. 
• Using a broker for hard money is not a bad idea.  Why?  Because there are plenty of HML's out there and not all of them work for all borrowers. Some have higher LTV's for the acquisition and don't cover all of the rehab.  Some cover all of the rehab and then cut your LTV for the acquisition while still others require payments during construction and others don't.  A good broker will be able to interview you and originate your loan for the HML that meshes best with your situation.
• Going directly to a lender can be a great idea although being tied to one lender means they can only lend based on their limited parameters.  Incidentally, there are some great national lenders on BP that may work for you, but the question is which one would work best. Like I said, that's where a broker comes in.

Hope that answers some of your questions.

Stephanie

Abby Weinstock · Answer

Check the lender's Google reviews, ask for references, and check the Better Business Bureau if they claim BBB accreditation to see what their rating is. Ask if you will have a dedicated person to speak with if you have any questions. Ask them to disclose ALL fees up front. Ask them how quickly they can fund the deal. Ask how long they have been in business to make sure they have an established track record.

Dave Spector · Answer

One other aspect you may want to drill down on with a potential lender: time to close. Often, borrowers find great opportunities and need a financial partner to move quickly. We've seen numerous instances where borrowers were attracted by low rates, only to discover that their low-rate lender could not move quickly enough to meet the close date... Typically, lenders investing their own funds can be more nimble.

Sanjiv Mehta · Answer

Thanks for the detailed reply @Jeff S.

Sanjiv Mehta · Answer

Thanks everyone. This list is turning out to be very useful for me and I am sure for others in my situation too. Keep adding your points of view.

What to look for when speaking to hard money lenders

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