An average person — and even real estate agents or conventional mortgage lenders — may have some questions on how hard money loans work. Maybe you know that more equity in the property, in the 30-40% range, is required than with a typical loan. Hard money loans are generally considered asset-based, so lenders used to look at the protective equity position (the difference between the real estate value and the loan amount) to decide if it was a good loan. But that mentality has changed significantly, as hard money loan requirements have expanded to keep pace with the demands of an ever-evolving industry.
This blog post will cover both general and specific hard money loan requirements, starting with a high-level project overview and moving into specific underwriting details. I’ll provide details for the items you need to know, covering the following sections:
Going into a project, you must be able to quickly explain what you’re planning: the cost; how much of your own money you have to spend; how long it will take; and the expected value of the finished product.
As a borrower, prepare to make your overall loan package as clear as possible for the mortgage broker and/or hard money lender. The more detailed and organized you are, the likelier you are to get approved.
You don't want to send a mortgage broker or hard money lender a mess of unlabeled documents to waste 30-45 minutes organizing and figuring out your loan request — only to realize it’s impossible.
Be clear, concise and organized with your loan paperwork to help the (busy) lender decide within one or two minutes whether to continue reviewing your loan request.
The executive summary is not always required, but for larger projects like a 100-unit apartment building construction loan, it can make a big difference to prospective lenders. A high-level yet highly detailed executive summary with answers to all the lender's likely questions saves everyone —from the borrower, broker and lender — valuable time evaluating your project.
The budget, also called a scope of work, must estimate costs in line with average costs for similar projects. For example, if you’re building a spec home on a steep residential lot, your budget will reflect a much larger excavation cost than a spec home on a flat lot. Most successful borrowers submit the budget provided by their general contractor (GC). If they themselves are the GC, they’ll create the estimates and submit their budget along with the loan package.
How much money will you invest in this project? For a refinance, how much equity is already in the property? Taking it one step further, you’ll want to document how much equity will be in the property after project completion.
Lenders want borrowers to have “skin in the game,” which means they've put their own money at risk along with the lender's. If you don’t have any money or equity at risk, don't expect to get a hard money loan.
I’ve written an entire blog post about the importance of your exit strategy. To sum it up: you need a well-thought-out exit strategy prior to applying for a hard money loan.
Most of the time, this exit strategy is clear to both borrower and lender — you’re either going to sell or refinance.
A Seattle investor recently requested a $600,000 hard money second mortgage on an existing rental property to buy another home to use as an Airbnb. When I asked about the exit strategy, there was silence. They didn’t know how they’d pay off the loan or even how to respond.
But their non-answers gave me all the answer I needed, which I recommended to the lender: pass on this loan.
Ambiguity makes a lender uneasy. Know and make clear your exit strategy at the time of application.
In this section, I’ll cover the specific items to submit with your application. Note that some, like entity documents, might not apply to your situation if the title will be under your name rather than a limited liability company (LLC) or corporation.
All hard money loans require some individual application information, including:
Since most of our borrower clients are real estate investors, the loans FCTD originates are usually held in an entity like an LLC, corporation or trust. Below are the items you’ll need to provide if you're vesting in an entity:
Are you buying a property in a different state from where your entity is registered (e.g. California entity buying property in Florida)? Depending on the lender, you may be required to register your entity in the new property state. Before you submit your Foreign Profit LLC or Foreign Profit Corporation application to the new state, you’ll need to:
You won’t be asked to order an Appraisal or Broker Price Opinion (BPO) — that’s the job of the mortgage broker or hard money lender. However, expect to provide recent interior and exterior photos of the property. (If you're buying a property with numerous online photos, you won’t need to provide photos.)
Each lender has different appraisal requirements.
Construction loan requirements encompass both fix and flip and ground-up construction projects.
When underwriting construction loans, we ask for the following items:
For a refinance, we need a copy of the most recent mortgage statement, which we send along with the Borrower's Authorization to the escrow officer, who will order the payoff demand. If we’re paying off another hard money loan, like a private individual you’ve been paying directly without mortgage statements, you’ll need to provide their contact information.
For a second mortgage, blanket or cross-collateralized loan, you’ll need to provide the following:
You probably didn’t realize it was so complicated!
For rental properties, we require tenant documents, including:
Insurance is mandatory on all financed properties. Below are key aspects of property insurance:
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Getting organized and doing your homework is the best way to breeze through the hard money loan requirements. As brokers, we originate 500+ loans each year — and of those, there may be only four or five borrowers who are highly organized with all their documents available. It's understandable. Most real estate investors are busy looking at future properties or working on existing ones. Yet, if you have it in you to be highly organized, it's worth it. Do yourself a favor and put your paperwork together before you apply for a faster and much smoother process.