5 Crucial Questions Hard Money Lenders Are Asking Themselves While You Are Applying for a Loan

There are many variables that must be considered in order for a hard money lender (also known as a private money lender) to approve a hard money loan. Borrowers expect a fast approval and funding process, so the hard money lender must quickly analyze the situation and determine whether or not the applicant will be approved for financing. Knowing how a hard money lender thinks is essential for a potential borrower who is preparing for the application process.

The Basics

1. What kind of property will be used as security for the loan?

Not all hard money lenders lend on every type of property. Some lenders will only do residential loans while others focus on commercial properties. Many lenders will not even consider owner occupied properties while others have the patience to go through the lengthier process necessary because of increased regulations for owner occupied loans. The hard money lender will quickly assess the borrower’s request compared to the lender’s capabilities to avoid wasting everyone’s time.

2. How much is the subject property worth?

The property value will be a primary factor in determining how much the borrower is able to borrow. Hard money lenders are asset-based lenders, which means the loans they provide are secured by real estate. The borrower generally has an idea of what they think the property is worth but the lender will need to dig deeper with a BPO (broker price opinion) or appraisal to verify the value.

3. How much do they want to borrow?

Most hard money lenders have a specific loan to value ratio (LTV) that they will not exceed for certain types of properties. For many lenders this value is up to 75% of the value of the property. The higher the LTV, the higher the risk for the lender. Ensuring that the borrower has some of their own equity invested in the property reduces the likelihood that the borrower will stop making payments if something goes wrong with the property or project. There are some lenders who will lend more than 75% LTV, but you can expect higher interest rates and points attached to these riskier loans. A higher risk loan for the lender equates to a higher cost loan for the borrower.

4. What will the borrowed funds be used for?

Different government regulations apply depending on the primary intended use of the borrowed funds. The hard money lender prefers that the funds are used primarily for investment or business purposes. If the primary use of the funds is for a consumer purpose (personal, family or household use), the loan will be considered a consumer loan and will be subject to additional regulations that will make the loan documentation more involved for both the lender and borrower.

5. What is the borrower’s plan for repaying the loan?

This is probably the most important question. The lender will need to know how the hard money loan will be repaid and require that the borrower spell out the plan. With trust deed investing, the lender’s number one priority is reclaiming their investment at the end of the loan term. In many cases the borrower intends to fix up the property being loaned against and then sell it as quickly as possible to pay off the loan balance. In other cases, the borrower may wish to pay off the hard money loan by later refinancing with a conventional loan from a bank.

After these initial questions are answered, additional questions will arise based on the specifics of the situation and requirements of the borrower. For this example, let’s imagine the borrower is requesting a fix and flip loan (also known as a rehab loan).

Fix and Flip Loan Questions

How much capital does the borrower have to put into the purchase and project?

For hard money loans and especially fix and flip loans (hard money rehab loan), the borrower must bring some of their own capital and have some skin in the game. This means having funds for a down payment, making payments on the loan until it’s repaid and capital for the rehab costs. The hard money lender may also want to see at least a small reserve set aside for any unexpected issues that will inevitably arise.

Does the borrower have any experience rehabbing properties?

Fixing and flipping isn’t as easy as they make it look on TV. An inexperienced fix and flipper can quickly get themselves into trouble if they don’t know what they’re doing. The lender wants to avoid this happening at all costs. A first time fix and flipper should prepare for some hesitance from hard money lenders. A seasoned fix and flip real estate investor who is able to show some successfully completed projects should have no problem winning the lender’s confidence.

What will the property be worth after repairs (After Repair Value or ARV)?

If the borrower’s plan is to purchase a house for $150,000, do $30,000 worth of repairs and then sell the property for $500,000 is that reasonable? Probably not. The hard money lender will need to look at nearby properties that will be comparable to the subject property once the rehab is complete and make sure the projected ARV is reasonable.

Is the plan to rehab the property reasonable?

Different levels of rehabs have different costs and timelines. Just doing a new kitchen and a little landscaping may only take 4 weeks and $20,000. Adding 1,000 square feet and major upgrades can take 6 months and $100,000+, especially when needing to pay for and obtain permits from the city or county. The lender will want to hear the projected costs and timelines associated with the scope of the project to ensure the fix and flipper’s plan is achievable.

These are just some of the questions going through a hard money lender’s mind during the borrower application process. Hopefully they will help prospective borrowers understand what is important to the lender and how they think and analyze potential hard money loans.

North Coast Financial, Inc. is a hard money lender in San Diego, California with 40 years of experience lending on properties throughout Southern California. For more information on our loan programs or to inquire about a loan please contact Don Hensel.
don@northcoastfinancialinc.com
760-722-2991