Friday, March 31st, 2017

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Hard Money Lending Less Risky Than Owning Real Estate?

(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.

Due Diligence…

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.

Good Investing!

Dyches Boddiford

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.


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About 

JP Moses is a roughly-hewn man-child who first got into REI after reading Rich Dad, Poor Dad back in Y2K and went full time in 2002. He's tinkered in everything from landlording to short sales to rehabs to Realtoring to REOs to notes to owner financing, blah, blah, blah...Till he finally stuck his flag deep into wholesaling and has since flipped somewhere north of a couple hundred deals.

JP's not a “guru” but also doesn't think it's a bad word. Among his core values are authenticity, creativity, big honkin' value, general fun-ness and being unshaven. He's super proud to be chief blogger guy at REItips.com and host of the free REIology podcast. He also thoroughly enjoys sharing his 53 best real estate investing forms with anyone who wants them. You should totally check that out. :-)

  • Martin

    I have a few hard money lenders that he should talk to about risk. They have lost more than 200,000 on two loans that were only 50% loan to value (appraisal by fee appraisers). They might disagree with his concept of safety. In a fast moving up market I agree with him but in a down market it can be very hazardous to your wealth. When an upside down borrower takes the carpets, the appliances, the cabinets and even leaves the windows open when they leave it may not be worth it to even try to get back your money.

  • Martin

    I have a few hard money lenders that he should talk to about risk. They have lost more than 200,000 on two loans that were only 50% loan to value (appraisal by fee appraisers). They might disagree with his concept of safety. In a fast moving up market I agree with him but in a down market it can be very hazardous to your wealth. When an upside down borrower takes the carpets, the appliances, the cabinets and even leaves the windows open when they leave it may not be worth it to even try to get back your money.

  • hmmm…….what Martin says is what I’ve been hearing about HMLs. So, what’s the real deal?

  • hmmm…….what Martin says is what I’ve been hearing about HMLs. So, what’s the real deal?

  • yea, i agree what do you say, hard money lending is less risky than owning real estate.

  • Now I better be careful and balance everything between hard money lending and real estate. I don't want to put all the eggs in a basket.

  • Given the economic downturn, I'd say that both are risky. However, what makes the big difference is having the right, reputable people that will lead you to the right direction.

  • Pingback: If You Want Less Risks, Be A Hard Money Lender! | REI News Watch()

  • In all fairness to Dyches, I will assume that this is more of a generalized article (with good information) and not really meant for today's market. Hard money lenders are taking hits left and right (just as the borrower is) and by no means navigating the waters casually. Anyone can look around and compare how many Hard Money Lenders actually exist in their individual real estate markets today versus 3-4 years ago.

    There are pro's and con's to being a hard money lender versus the wholesaler/flipper/rehabber in both up, sideways, and in down markets. It's just another tool a real estate investor can implement to create wealth with real estate.

  • I see where you're coming from, Tyler. But also Dyches actually put the article out just recently, preceding his workshop on how to become a hard money lender. Yes, many got burned bad in the last few years…but not all of them. There are still some doing business, and they're more in demand now than ever.

    Thanks for commenting,

    …jp

  • I think some of the points made in this post are being missed in the comments. Low LTV (60% or less) and short terms (1 to 2 years) will significantly reduce the risk of complete loss of capital. Another way to reduce risk is to employ a reputable underwriter, who will perform the due diligence and present only the investments which meet the lender's investment parameters.

  • Kurtis

    I am new to real estate investing and I’m trying to fully understand how hard money loans work with the real estate investor. Since the loan is usually short term, does this mean in order for the real estate investor to pay back the loan and make a profit he would HAVE to sell the house to get the full value for the house back, not being about to rent it out monthly?

  • Hi, Kurtis. Yes, hard money is a short term financing solution. It’s intended to be replaced quickly – within a matter of months. So it’s ideal for houses you’re going to resell as soon as possible. It would not work for long term keepers, like rentals.

    My best,
    …jp

  • Kurtis

    Thank you for the reply. Okay so if I did want to keep a property to rent out for a steady monthly income, what would be the best approach?

  • You’d either:

    1) Get an investment property loan (720 credit score a minimum)
    2) Get the owner to finance it (possible with the right circumstances and motivation)
    3) Do a lease purchase or lease option (basically rent-to-own)

    That’s about your options. Make sense?

    …jp

  • Nice share and I am do agree with you. If you are one of the many of us looking for a reliable and expeditious way to meet a substantial financial need, going to hard money lender is one of the best option you have on hands.

     

  • Money lenders companies that is going to be on the same web page as what your financial commitment scribe is, is essential but it may also be essential as you are looking for cash bank to discover the cash bank first and then to perform on your financial commitment technique. So you might not want to get so particular on the elements you are trying to do as a property buyer until you discover a decent cash bank.

  • Bob

    How many private money loans can I do per year without having to have a lender’s license?