(Contributor: Dyches Boddiford)Yes, hard money lending is less risky than owning real estate!
Think about it. Done properly, your loan will be secured by real estate worth much more than your loan.
Personally, loans I make are no greater than 60% of the fixed up price of the property. And if there is much fix-up to be done, I escrow the repair funds and provide draws only as the work gets done.
As a hard money lender, you will only loan on property you would not mind purchasing for the loan amount the day you make the loan. That way you will not mind taking over the property if the borrower defaults. Therefore, you will not make loans on property or in areas you do not feel comfortable.
Another risk common in most loans is the credit worthiness of the borrower. As a hard money lender, this is a minor issue. You are primarily looking to the property itself to return your capital and a nice profit in the event of a default.
As a hard money lender you also avoid the risk of tying up your capital for long lengths of time. Since your loans are relatively short duration, you have your capital back for other projects, loans or for your personal use. This allows you to quickly respond to changing economic conditions and neighborhoods.
The higher rates charged on these loans provide an excellent buffer for inflation and rate changes in the market. Want further protection? Rates can even be variable or you can participate in the profits!
If you already understand real estate, hard money loans are really low risk and cannot be beat for the returns on your capital and time.
One of the most important things a hard money lender does to be successful is doing good “due diligence.” That means checking out the collateralizing property and the borrower. Where the conventional lender concentrates on the ability of the borrower to pay back the loan, the hard money lender concentrates on the property and its ability to repay the loan.
The knowledge to do good due diligence and access the viability of the project is why every successful hard money lender has a background in real estate or has someone they can depend on who does.
More important than the property is the neighborhood. The types of people the neighborhood attract will determine the kind of people attracted to the property.
- How much competition is there?
- Are there indications of disposable income and/or credit among the neighbors?
- What is condition of other property?
These questions are important to answer before even considering the property itself.
Next the property is evaluated along with the investor’s background and ability to do what he or she says they can do. Trust but verify.
A good hard money lender wants their borrowers to make money. That way the lender is sure to get paid and their borrower will come back for another deal…again and again!
Foreclosure and Dealing With Default…
Of the many loans over the years, I have had to do very few foreclosures. Upfront due diligence and proper paperwork go a long way to making a successful loan. Although foreclosure should be considered the last ditch effort to collect on your loan, you still need to be aware of the requirements in the state you are making your loans.
With a properly structured loan, this concern can be minimized. For example, by keeping the loan-to-value ratio low, other lenders that loan at higher LTVs may cash you out in case of a default. Or the borrower can sell the property at a lower price and still pay you in full. And if it does go into foreclosure, there is more equity to cover costs of foreclosure, holding and fix-up for subsequent sale. There are other ways to lower your risk as well.
You should be aware of the foreclosure process in the state where you will be lending.
Each state is different, but there are basically two procedures. All states allow the use of the mortgage. In these states (referred to as lien-theory states), a court action must be initiated and an approval of the court must be gotten before the actual foreclosure sale. The process can run from a few months to well over a year. And you don’t get paid while you wait.
The second type involves the use of the trust deed. In these states (referred to as title-theory states) a non-judicial foreclosure can be done. Usually, these are the quickest–some as quick as three to four weeks of advertising and then the sale.
Be aware that the term “mortgage” is used as a slang term for both kinds of instruments, so don’t automatically assume you know which your state allows. You will need to be aware of the procedure so you can know how to minimize the time and cost.
However, you should be prepared to handle a default even before foreclosure by a willingness to address the default early. Often the borrower can be convinced to get the project done and continue payments if they are not far behind and have not gotten totally discouraged.
This may also be an opportunity to buy the property from them at your loan balance plus a little to encourage them to deed the property over to you. This is business, so it does not pay to get mad and belittle them. Besides, if you did your due diligence and structured the loan properly, you should make much more profit on a default than if the loan was paid as agreed.
If profiting from being a hard money lender is something you might seriously consider, you should consider attending my soup-to-nuts online class about How to Become a Hard Money Lender.
About Dyches Boddiford…
Dyches Boddiford has been investing in real estate since 1980 and is a national speaker. He speaks from experience in single family homes, owning apartments, mobile homes, buying discount mortgages, hard money loans, developing, including using land trusts and land contracts. You can get information on his upcoming classes and sign up for his free newsletter www.Assets101.com.