Not everyone will qualify for a conventional loan, but that does not mean the risk of lending to these individuals or companies is especially high. In certain industries, including construction, private lending is common. Such transactions are known as hard money loans. How do you become a lender? If you have the capital and the right mindset, it’s a matter of doing your homework regarding the proposed project and performing your due diligence.
Hard Money Loans
Real estate financing is complicated, and many in the construction business would rather obtain pricier hard money loans quickly rather than wait for conventional loan approval. Hard money loans are basically short-term bridge loans, lasting between six months and five years, secured by real estate. Banks do not provide hard money loans, but private lenders do. Such loans play a crucial role in real estate construction financing.
Types of hard money loans include those for:
- Fixing and flipping
- Real estate investing
Hard money loans do not generally apply to homeowners seeking funds to purchase or upgrade a residence. Instead, they are geared toward investment properties and construction projects. Unlike conventional lenders, hard money lenders are not that concerned about a borrower’s creditworthiness. Instead, they concentrate on the underlying value of the collateral property.
Lenders charge higher interest rates for hard money loans, but the short-term of the loan and lack of hassle makes sense for the borrowers’ needs. Because real estate secures the loan, there is no need for the amount of paperwork necessary for a standard construction loan.
How to Become a Hard Money Lender
Hard money lending is not for the faint of heart. Becoming a hard money lender requires more than capital, although that is essential. You will also need to know the intricacies of the local real estate market. That includes zoning and permitting, as well as current construction costs. Only consider lending after thoroughly immersing yourself in these details.
Hard money lenders focus on local markets because venturing beyond usually makes the risk untenable. Knowing the true value of collateral property is critical. You must develop the ability to thoroughly evaluate every proposal.
In addition to educating yourself about the local real estate scene, you’ll need to put together a team to assist you in the decision-making process. This includes an attorney, accountant and other financial professionals. You will need advice regarding each deal’s tax implications, along with a strong risk assessment.
Once you have the capital, you need to find borrowers in need of funds. Get started by joining peer-to-peer lending platforms, which connect lenders with borrowers.
Private Lending Risks and Rewards
The downside of private lending is borrower default. Good verification beforehand can limit this possibility. Keep in mind that a percentage of those looking for private lending options are indeed fraudulent, which is where your team’s due diligence comes in. Sometimes the borrower isn’t perpetrating a deliberate fraud, but their potential numbers will never add up.
While the property secures the loan, there is always the chance that unloading it if the buyer defaults is harder than anticipated. A property worth X in a rising market is worth a lot less in a downturn.
Never risk too much of your capital on one deal. Even loans that look excellent on paper can go south. Avoid investing in anything you do not understand completely. That’s especially true in common private lending investments outside of real estate, such as start-up financing. If you lend to a business, you might end up with those assets in a worst-case scenario. Without an in-depth understanding of the nature of the enterprise, turning it around may prove unlikely.
Expect you may end in court over a deal that didn’t work out. That’s where good legal representation from the outset pays off.
Those are some of the risks, but the rewards are substantial. Private lenders might charge between 12 and 20 percent on their loans, along with 3 to 6 points. That’s a lucrative rate of return on investment, without question.
How ScoreMaster Can Help
When it comes to private lending, verification is key. Clients may not qualify for a conventional loan due to previous foreclosure or some other financial stain on their record. ScoreMaster, our gamified system allowing borrowers to achieve their best credit score, assists both the lender and borrower. As a private lender, ScoreMaster helps you ensure applicants are truly qualified. Borrowers benefit by receiving approval for a loan on which a conventional lender might pass. Contact us today.
*Legal Disclaimer – ScoreMaster is a patent-pending educational feature simulating credit utilization’s effect on credit scores via payments or spending. Your results may vary and are not guaranteed.