Hard Money Lender is a relatively new term used to refer to loan professionals who specialize in private money loans. In the past, these professionals had a multitude of labels, including, “private money lenders.” Regardless if you prefer the term hard money lender or private money lender, they both provide the same service.
While some investors may choose to work alone when originating notes, most will rely on the expertise, skills, and services a hard money lender provides. If you are looking to work with a hard money lender, this article is perfect for you.
In order to make a decision if working with a private lender is right for you, you will first need to understand everything private money lenders bring to the table with regard to your note investments.
Just Starting Out
If you are just starting out, the services of hard money lenders are invaluable as they will help walk you through the transaction, connect with experienced attorneys and CPAs for advice, and evaluate a loan file for quality and risk; eventually resulting in an investment opportunity for you. Most investors who are not real estate professionals maintain life-long relationships with their hard money lenders just as a business executive would maintain a relationship with an investment advisor.
The best part about using hard money lenders to invest in loans is that the fees for their services are typically paid by the borrower and therefore you get the benefit of the expertise without the cost. Well, at least you are not paying for it directly. You pay for it indirectly because of the additional fees you would likely collect if you originated the loan yourself.
For example, if the borrower was willing to pay 3 points up front for a $500,000 construction loan (3% * $500,000), you may earn the entire $15,000 fee up-front as the sole investor and originator. But, if you use a hard money lender, you may only get a piece of that commission; typically, 1 point.
Traditional vs. Hard Money Lending
In traditional lending, the loan officer’s primary role is on the front-end of the transaction. This includes activities such as, but not limited to: taking in the application, discussing loan programs and their qualifying criteria, as well as gathering the income and asset documentation from the borrower. The loan file is then sent to processing, underwriting, and closing staff who see it through to settlement. Lenders, or funding sources, are provided to the loan professional by the company or bank at which the loan officer is employed.
In hard money lending, the front-end of the transaction is just the tip of the iceberg, as the following processes are often personally managed to get a loan closed:
- Creating the loan package, including the application, income, credit, and asset documents the borrower provides,
- Gathering and reviewing title information as required,
- Ordering payoff and loan reinstatements as needed,
- Providing the borrower with all applicable federal and state disclosures,
- Ordering and reviewing an appraisal or other asset valuation on the property,
- Coordinating title and escrow services,
- Underwriting and approving the file, and
- Creating final loan documents and coordinating the funding with you for loan settlement or closing.
After the loan is closed, hard money lenders may also service the loan for a monthly fee.
Let’s look closer at each step.
Step 1: Creating the loan package
A well-documented and detailed loan package is key to making an underwriting decision. Private money lenders will run a credit report, require tax returns for the previous two years, as well as request financial statements, including bank and investment statements along with a variety of other documents that provide proof of credit, assets, and liabilities. They will also assist the borrower in completing the loan application (frequently referred to as the 1003), as well as a document called a Statement of Information (SI). The SI assists the title company as they research the title of the property for liens and judgments.
Remember, the documents required will be unique to the type of loan and to each borrower’s personal financial situation. What separates a great hard money lender from a novice is they will intimately know which documents will provide them and you with the information needed to make each investment decision.
Step 2: Gathering and reviewing title information
A preliminary title report is an offer to insure a transaction by the title company and includes a summary of the existing liens, judgments, easements, and other encumbrances on the property. Title companies extend an offer to insure a transaction subject to the information in this report. Title insurance is, and should be, a mandatory requirement of any investor.
Step 3: Ordering payoffs and reinstatements
Ordering payoffs and reinstatements for a real estate loan is trickier than it sounds. A payoff is a document from a lien holder specifying the exact amount to payoff the lien in its entirely. A reinstatement is a statement from the lienholder (typically a mortgage or trust deed) which gives an exact amount to bring a delinquent loan current. Depending on the type of lien, the payoff may be obtainable in a few days, or it make take several weeks. In a conventional transaction, this function is typically handled by escrow. But a good hard money lender knows that last minute problems often arise because of inaccuracies in these documents and the will often obtain these documents to ensure accuracy. Hard money loans are very loan-to-value sensitive and an unexpectedly high payoff can derail the loan at the last moment.
Step 4: Providing disclosures
Federal and state disclosures differ depending on the type loan. These disclosures provide a borrower with key information about the loan they have applied for and are designed to inform and protect the borrower. For example, a first mortgage loan on a residential property requires different disclosures than a commercial loan against a warehouse. The private money lender provides the necessary loan-specific forms within the required time frames and reviews them with the borrower.
Step 5: Ordering and reviewing an appraisal
Property values will make or break a private money deal because the value of the underlying collateral is scrutinized heavily when making an investment decision. Value can be determined many different ways, and private money lenders will explain the options to you to determine the best valuation report for the transaction.
Many investors prefer to visit the property themselves to determine value but it is typical they also require an appraisal performed by a licensed appraiser. This can be in addition to any other methods you and the hard money lender determine necessary, such as Broker Price Opinions (BPOs) and Automated Valuation Models (AVMs). A BPO is a report provided by a licensed real estate broker which generally costs less, and is substantially less detailed than an appraisal. However, it does provide a quick sense of what the property would list for in the current market environment. An AVM is a report that relies upon public records and special modeling software to arrive at a value. Whichever methods of valuation you decide to require, your private money lender will order the reports, and coordinate access to the property.
Step 6: Coordinating title and escrow services
Typically simultaneously, private money lenders order a title report for the purposes of title insurance, and escrow services are also engaged. In some states, the same company will provide both the escrow and title services (i.e. Michigan) and in others, a separate company or possibly an attorney will oversee the process (i.e. Georgia).
The escrow services company will obtain any payoffs needed on the subject property, handle the disbursement of funds, conduct the loan closing, and record all applicable deeds and documents with the county. The private money lender also coordinates the transfer of your funds to the escrow company handling the transaction.
Step 7: Underwriting and loan approval
The private money lender underwrites and approves the file based on your criteria requirements. Prudent review and documentation is required to justify a loan approval. The private money lender's professional reputation and potential future business with you will be impacted by the performance of this loan. You may choose to personally review the file or have your own designated underwriters review the loan package.
Step 8: Final documents and closing
All the required final deeds/mortgages and loan documents must be prepared by the private money lender, an attorney, or by a designated document preparation company. The actual closing and signing of loan documents process varies by state. Sometimes the private money lender will have a notary on staff and will supervise the signing of the loan documents, and in other states, an attorney, escrow or title company will coordinate the signing. The signing location and supervising entity will also vary based on the type of transaction. In many cases, the private money lender will attend the closing to make sure everything is in order and there are no questions about the final documents.
The private money lender will coordinate with you to have funds transferred to the escrow services company for loan closing. Or, in some cases, you may be purchasing an existing note that the private money lender has already funded, in which case the funds would flow directly to the private money lender.
Step 9: Loan servicing
The loan servicer is the individual or entity that collects the monthly payment, creates periodic loan statements, provides year-end tax documents, and manages the escrow account for taxes and insurance. It is common for private money lenders to provide this service. Expect to be charged a monthly fee for this service; the loan servicer will generally deduct this fee from the monthly payment before remitting it to you. Servicing loans is how most private money lenders earn a large portion of their income, and cover their office overhead. Servicing a loan also gives the private money lender the ability to communicate more quickly with you about the status of your note investment. If the private money lender is not the servicer, the private money lender will transfer the loan documents to the designated servicer.