Getting your hard money loan approved doesn’t have to be difficult. In fact, getting a hard money loan approved through a hard money lender should be much easier than a traditional bank. Because of strict lending guidelines, many borrowers, including real estate investors, cannot obtain a purchase loan or refinance loan from a traditional bank. In many cases, they have poor or no credit, don’t show consistent income, or the real estate they are borrowing against doesn’t meet specific criteria. For this reason, hard money lenders play an important role in the real estate financing industry.
The most common hard money loans are the hard money fix and flip loan, hard money bridge loan, or hard money construction loan. Of those loan types, the purpose of the loan maybe a hard money purchase loan, hard money refinance loan, or a hard money cash out refinance loan. Often these loans need to be funded quickly, typically in 5 to 7 business days, and rely primarily on the underlying real estate asset, also known as the “collateral,” to secure the loan as opposed to the borrower’s credit history or cash flow.
The following is a list of the top 5 things you can do to get your hard money loan approved. Please keep in mind, due to federal and state requirements regarding owner occupied hard money loans, we are focusing on non-owner-occupied business purpose loans in this article.
The loan to value ratio, commonly referred to as “LTV ratio,” is one of the most important underwriting factors a hard money lender considers when approving a hard money loan request. Because many borrowers applying for a hard money loan have poor credit or little cashflow, the hard money lender must rely more heavily on the collateral for repayment. This differs from traditional banks who will place much more emphasis on the borrower’s credit history and income to qualify a loan request.
The loan to value ratio is calculated by dividing the loan amount by the value of the property. For example, if the loan amount is $100,000 and the value of the property is $200,000, the LTV ratio would be 50% ($100,000 / $200,000 = 50%).
The loan to value ratio is important because if the borrower were to not make the payment, the property would need to be sold and the sale proceeds would need be used to repay the loan. If there were not enough sales proceeds from the sale to repay the loan, the hard money lender would be at risk of losing money. Leaving a substantial cushion between the loan amount and the market value of the property reduces the risk that the hard money lender will lose money on the loan if the borrower defaults. That is why most hard money lenders will cap their loans at 70% of the property value.
The collateral, or real estate type, is also an important determinant in obtaining a loan approval from hard money lenders. Because private money lenders rely less on the borrower’s credit or ability to pay, they must consider the collateral type to ensure repayment of their loan.
The most common property type used for a hard money loan, is the single-family house or multi-family apartment building. Both property types are easy to value and make up the overwhelming number of real estate sales. Other property types hard money lenders may finance include industrial, commercial, retail, office, and hotels. Each of these property types offer more risk to a hard money lender and therefore LTV ratio caps are typically lower.
The riskiest real estate property type for a hard money lender to finance is land. Because land does not produce income and the value is based upon some future use, land can be difficult to obtain a hard money loan. A borrower seeking to finance land, will most likely put 50% down on a purchase, show strong credit and cashflow, and have a strong exit strategy (discussed later in this article).
It is true that hard money lenders rely on the real estate collateral and LTV ratio more than the borrower’s credit or cashflow when considering a hard money loan request. However, a hard money lender will most likely require a credit report and they will look for a history of late payments on revolving credit lines, loan defaults, bankruptcies, outstanding judgements, and other derogatory items that could jeopardize the repayment of the loan. Most hard money lenders do not want to fund a loan in which a borrower has a high likelihood of not making the payment.
Like credit, the ability for the borrower to make the payment is an important factor when obtaining an approval for a hard money loan. Most hard money lenders will not require tax returns, w-2’s, or other income verification documents, however, they will want to understand how the borrower intends to make the payment. Additionally, the hard money lender may request documentation substantiating the borrower’s explanation of how they intend to make the payment.
Another important factor that a hard money lender considers when approving a private money loan is the repayment the loan. Usually the repayment of a hard money loan occurs through the sale of the property or a refinance of the loan. In either case, the hard money lender will want to understand how the borrower intends to exit the loan.
Common questions a hard money lender may ask regarding the repayment depends on the exit strategy. For example, if the borrower is intending the sell the property, hard money lenders may ask about an active listing agreement, estimated sales date, improvements to the property prior to the sale. If the borrower intends to refinance the loan, hard money lenders may ask about an existing refinance, credit or cashflow enhancements that would make the borrower more attractive for a traditional bank loan, and any future improvements to the property securing the loan.
Obtaining a private money loan through a hard money lender can be a simple and quick process if borrowers understand how hard money lenders approve loans. Borrowers need to be prepared to respond to questions regarding the LTV ratio, the real estate securing the loan, their credit and cash flow, their ability to pay, and the exit strategy. Understanding these items will increase a borrowers likelihood of getting their hard money loan approved.