Evaluating the Risk and Return of a Hard Money Loan Investment
Deciding whether or not to engage in a hard money loan investment takes careful consideration. After all, you’ll want to evaluate the risks and returns of the investment type. Additionally, it depends on what type of real estate you’re investing in. Either way, knowing the potential risks and what types of returns you’ll get from the investment is crucial. Today, we’ll review some of the top considerations and calculations while pursuing a hard money loan investment.
Contents of This Article:
- What Is a Hard Money Loan Investment?
- What Are the Risks of Hard Money Loans?
- How to Calculate the ROI of a Hard Money Loan
- Are Hard Money Loan Investment Risks Worth the Returns?
- How to Find a Reputable Local Lender
What Is a Hard Money Loan Investment?
If you’re engaging in a hard money loan investment, you’re most likely buying real estate. Depending on the project or type of real estate, some investors may not qualify for traditional financing. Or, they may need the capital quicker than a conventional lender will allow. As such, they turn to residential hard money lending for fast, easy-to-access capital for their next investment. Here are some examples of how people use hard money loans for their real estate purchases.
- Real Estate Investments- Real estate investors often use hard money loans to finance properties. For instance, some investors use them to quickly secure residential, commercial, or land investments in competitive markets.
- Fix-and-Flip Projects- Investors who buy distressed properties to fix-and-flip them to resell for a profit can rely on hard money loans. Convenient access to funds allows them to purchase and renovate the property quickly, with no delay in obtaining the loan.
- Construction and Development- Property developers may use hard money loans to fund the construction or development of real estate projects. These loans can provide capital to cover construction costs and bridge the gap until the project is done or a traditional loan is secured.
- Bridge Financing- Borrowers can also secure hard money loans to serve as a short-term bridge. Bridge financing can help cover financial gaps or expenses until borrowers secure long-term financing or sell their property.
What Are the Risks of Hard Money Loans?
Although hard money loans benefit investors needing quick capital, it’s important to understand some of the risks. So, if you’re evaluating a hard money loan investment strategy, here are some things to consider.
- Higher Interest Rates- Hard money loans often carry higher interest rates than traditional bank loans. Depending on your lender, rates can range from 7% to 15% or more. As such, the higher interest costs can significantly increase your overall borrowing expenses.
- Collateral Risk- Hard money loans are secured by real estate. So, if borrowers default on a loan, they risk losing their property to the lender.
- Short-Term Nature- Typically, hard money loans are short-term, with terms ranging from a few months to a few years. So, borrowers must have a clear and feasible exit strategy to repay the loan within the given timeframe.
- Refinancing Challenges- Some investors plan to refinance a hard money loan with a traditional loan after a short-term period. However, there’s a risk that you may not qualify for the loan.
- Limited Availability- Private investors or small lending companies typically offer hard money loans. As such, the availability of hard money loans can vary depending on the local market and lenders. It may be challenging to find hard money loans if lenders aren’t actively funding specific property types near you.
How to Calculate the ROI of a Hard Money Loan
Return on investment, or ROI, is an important metric for evaluating the profitability of your investment. So, before you seek a hard money loan, it’s important to understand the costs, fees, and how you’ll make a profit. By carefully analyzing the ROI, you can make more efficient and informed loan decisions. Here are some of the important calculations and numbers to consider to evaluate the ROI.
- Identify Total Investment Costs
- Estimate Property Income
- Determine the ROI
Identify Total Investment Costs
To find your ROI, you’ll want to start by determining the total loan amount you need from the hard money lender. This is what you’ll need to repay, plus interest.
Then, you’ll want to include any fees charged by the lender, like origination, underwriting, or processing fees. Additionally, consider the costs associated with closing the loan, like insurance, appraisal fees, and escrow charges.
Don’t forget to account for property taxes, insurance, repair or renovation costs, and regular maintenance expenses.
Project Property Income
Next, you’ll want to estimate the potential income from the investment.
For instance, if the investment property is intended for rental purposes, estimate the monthly rental income you expect to receive. Additionally, it’s important to factor in vacancy rates to account for periods when the property might be unoccupied. Or, if you plan on fixing and flipping a property, estimate your projected selling price.
Determine the ROI
Finally, to calculate the ROI, you’ll want to first find the net profit, which is the difference between the property income and property expenses. Then, you can use this formula to determine your ROI.
- ROI = (Net Profit / Total Investment Costs) x 100
If this seems confusing, we’ll go over an example using real numbers below.
Example of Calculating ROI
Suppose you’re looking at a hard money loan for a fix-and-flip project that costs $200,000 to purchase. So, you make a down payment of $40,000 and get a hard money loan for the rest, equalling $160,000. Additionally, suppose you have a 10% interest rate and a 12-month loan term. After renovations, your goal is to sell the property for $275,000.
Using that information, here’s how to find your monthly interest rate.
- Monthly Interest Payment = (Loan Amount x Annual Interest Rate) / 12
- Monthly Interest Payment = ($160,000 x 0.10) / 12 = $1,333.33
From there, you’ll want to determine how much renovations will cost and how much you’ll pay in loan fees, taxes, insurance, and maintenance. Here are the numbers we’ll use for this example.
- Estimated Cost of Renovations = $50,000
- Loan Fees = $5,000
- Estimated Yearly Property Taxes = $3,000
- Yearly Property Insurance = $1,200
- Maintenance and Repairs (per year) = $2,000
Now, we’ll get into how to find the ROI. First, you’ll need to calculate your total investment costs, loan costs, total interest payments, expenses, and projected net profit.
- Total Investment Costs = $210,000
- (Purchase Price + Renovation Costs)
- Loan Costs = $165,000
- (Loan Amount + Loan Fees)
- Total Interest Payments (12 months) = $15,999.96
- (Monthly Interest Payment x 12)
- Property Expenses = $6,200
- (Property Taxes + Insurance + Maintenance and Repairs)
- Projected Net Profit = $42,800.04
- Projected Selling Price – Total Investment Costs – Interest – Property Expenses
- $275,000 – $210,000 – $15,999.96 – $6,200 = $42,800.04
- ROI = 20.38%
- (Projected Net Profit / Total Investment Costs) x 100
- ($42,800.04 / $210,000) x 100 = 20.38%
Are Hard Money Loan Investment Risks Worth the Returns?
Ultimately, it’s important to calculate the ROI to determine whether your investment is worth the risk or not. That said, the higher the ROI, the more profitable your investment is. However, a lower ROI suggests less favorable returns.
So, if you’re looking for the best possible outcome, calculate the ROI of other investment opportunities. That way, you can compare and contrast certain investments and make more informed decisions.
Before pursuing a hard money loan, borrowers should thoroughly evaluate their financial situation and assess the risks. Additionally, it’s important to have a clear plan for repaying the loan within the specified timeframe.
How to Find a Reputable Local Lender
Evaluating the risks and returns of hard money loans is a crucial step in finding a profitable investment type. Once you’ve done all the calculations and have determined the ROI for your hard money loan investment, the next step is to find a reputable lender. To do this, you’ll want to look locally.
Maryland Hard Money Lenders offers quick, efficient loans for your real estate investments. Whether you need a fix-and-flip loan, rental property loan, or bridge financing, we’ve got you covered. So, if you’re looking for a reputable local lender, contact Maryland Hard Money Lenders today or fill out an application here.
