How to Minimize Risks in Hard Money Lending
In the fast-paced world of real estate investing, hard money loans have become increasingly popular due to their quick accessibility and flexibility. However, like any investment, hard money lending has certain risks that both lenders and borrowers must be aware of. Today, we’ll review some of these red flags and how to mitigate risks in hard money lending.
Contents of This Article:
- Why Is Hard Money Lending Risky?
- Common Risks in Hard Money Lending
- How to Minimize Risks in Hard Money Lending
- Find the Right Lender to Work With Today
Why Is Hard Money Lending Risky?
Hard money lending can be risky for both borrowers and lenders. For instance, hard money lenders provide loans with more lenient requirements. This means that borrowers don’t need as many hard money loan qualifications as they would for a traditional mortgage loan. Most traditional lenders look at borrowers’ credit history, income, debt-to-income ratio, and more. However, hard money lenders mostly care about the value of the property used as collateral, meaning borrowers may be less experienced or less qualified in other lender’s eyes.
Additionally, hard money loans are funded much quicker than other loan types. As such, the speed of funding can also pose a risk to lenders, as they have less time to analyze deals. For borrowers, this means that lenders often charge higher interest rates to mitigate their risk. In turn, this poses risks for borrowers as they’re paying more for the loan. Unfortunately, if their deal doesn’t work as planned, they could lose their asset, losing money in the end.
That said, there are ways for both lenders and borrowers to mitigate risks in hard money lending. First, we’ll go over some of the most common risks for both parties; then, we’ll discuss how to mitigate them.
Common Risks in Hard Money Lending
There are several risks in hard money lending for both borrowers and lenders. Understanding these risks is important if you’re considering using a hard money loan for your next real estate investment. Here’s what to consider.
Risks for Borrowers
- High-Interest Rates– Hard money loan interest rates are generally much higher than traditional loans. This is mostly because these loans are shorter, and hard money lenders take on more risk. As such, interest rates for hard money loans usually range from 7% to 15%.
- Short Loan Periods– Repayments are usually structured over a shorter period of time, meaning borrowers have less time to pay off the loan. Loan periods usually range between 6 and 18 months. As such, borrowers must come up with a plan to meet their repayment obligations in time.
- Higher Costs– Another risk for borrowers is that there are higher origination fees and closing costs for hard money loans. Along with larger down payments, these extra costs are crucial to keep in mind because they add to the total financial risk for borrowers.
- Lower Loan-to-Value Ratio– The loan-to-value ratio (LTV) compares the loan size to the value of an asset that’s purchased using the loan funds. Since hard money loans use the property as collateral, a lower LTV is associated with these loans, so borrowers pay more upfront.
- Potential Market Changes– Drastic changes in the real estate market can leave borrowers scrambling, as they often rely on the sale of their investment property to cover the hard money loan. If the sale doesn’t go as planned, borrowers can be left with a lot less money than they planned.
Risks for Lenders
- Borrower Could Fail to Pay– The largest risk for hard money lenders is the chance that the borrower’s deal might fall through, leaving them unable to repay their loan. To mitigate this risk, lenders use the asset as collateral so they can get their money back if the borrower defaults on their loan payments.
- Flexible Criteria Means More Risk– Hard money lenders use more flexible or different criteria than most traditional lenders. However, this increases their risk because they often take each borrower on a case-by-case basis. Without focusing too much on credit history, hard money lenders must evaluate other criteria to decide whether or not they’ll fund an investment property.
How to Minimize Risks in Hard Money Lending
Minimizing risks in hard money lending involves due diligence, thorough planning, and clear communication between lenders and borrowers. Here are some key tips to help minimize risks in hard money lending.
- Thorough Due Diligence
- Find a Reputable Lender
- Look for Hidden Costs
- Ensure Transparent Communication
- Know Your Finances
Thorough Due Diligence
Most of the risk associated with hard money lending comes from your property being used as collateral. As such, borrowers need to analyze the investment property for which they need funds to ensure a successful deal. For instance, you’ll want to calculate the potential cash flow, analyze the location, and look at the annual return on investment.
Find a Reputable Lender
Once you find a good property deal, you’ll want to look for a reputable lender with a positive history of working with similar borrowers. You may want to seek out testimonials or references from past clients. After all, a reputable lender is more likely to provide transparent terms, more reasonable fees, and reliable support throughout the lending process.
Look for Hidden Costs
Carefully look over your loan agreement for any hidden fees or costs. Additionally, ensure that your hard money lender clearly communicates all associated expenses. This includes origination fees, interest rates, potential penalties, and more. Understanding the full cost of the loan upfront helps you make more informed financial decisions.
Ensure Transparent Communication
Choose a lender that prioritizes transparent communication. Ensure that the lender clearly explains the terms of the loan, the repayment schedule, and any potential risks involved. A lender who values open communication will more likely address your concerns and work with you throughout the loan term. On the other hand, you’ll want to clearly communicate with your lender as well. If you think you’ll be late with a payment or are struggling to repay your loan, speak with your lender as soon as possible.
Know Your Finances
Understand your own financial situation and goals before seeking a hard money loan. Being realistic about your ability to repay the loan within the specified terms is important. Knowing your finances allows you to select a loan that aligns with your capacity and helps you avoid potential financial strain.
Find the Right Lender to Work With Today
If you’re thinking about financing a new real estate investment, it’s important to know all of your options. While hard money loans are a great way to fund a property quickly, knowing the risks of hard money lending is crucial. Ultimately, borrowers and lenders must know how to perform due diligence to ensure they both get a good deal.
Looking for a hard money loan near Baltimore? Look no further than Maryland Hard Money Lenders. Our team of loan experts can help you fund your next investment property quickly and efficiently. We offer loans for rehab properties, investment properties, rentals, and more. Contact MHML today to learn more about our lending process, or fill out our initial loan application today!