With 40.8% of the total houses flipped in the first quarter of 2021 being purchased with finance, investors are more likely to take loans to invest in real estate. Investors are willing to put money down to raise capital or funds to purchase, rehab, or flip an investment property. Hard money loans need a higher amount of the loan as a down payment compared to conventional loans.
The down payment is necessary for an investor to secure a hard money loan. This not only shows that you are interested but also gives a lender the required assurance that the loan will be paid off in the specified time frame or the loan term. The amount an investor will have to put down primarily depends on the potential after-repair value of a property and the loan-to-value (LTV) ratio on which the lender will decide to provide a loan.
Why Do Hard Money Loans Require More Down Payment than Conventional Loans?
Real estate is a risk-oriented profession; often the hard money lenders are at a bigger risk as they are the ones funding your real estate investment project. To make sure they have enough funds to bear the interest rate, closing costs, origination fees, loan points, etc. lenders require a borrower to put some money in advance towards the down payment.
The down payment ensures that you are a serious investor and have skin in the game. The amount you’ll have to put down may vary from lender to lender. Some lenders will also look at your credit score and your experience in real estate investment.
Hard money loans need a borrower to put more on the down payment as compared to the conventional ones. Conventional loans have a strict underwriting process that allows them to get access to information regarding the investor’s income, assets, cash reserves, funds, etc. to secure the loan.
Hard money lenders have flexible terms and bypass all the scrutiny to provide loans quickly to further invest in real estate. The underwriting process is simple and requires fewer documents for verification. The major factor here is the risk of lending. The property on offer as collateral is the only security in hard money loans. Thus a lender tends to provide the loan based on the after repair value. The lender will determine the after-repair value of the property through a professional property appraiser. The appraisal will help a lender determine the cost of repairs and the after-repair value of the property.
How to Determine the Required Down Payment?
The loan-to-value (LTV) ratio of the property plays a major role in determining the required down payment for a hard money loan. Lenders use the loan-to-value (LTV) ratio to assess the risk involved in funding an investor’s real estate investment project. The lender determines the LTV ratio and approves a loan amount according to it. If a lender offers to loan 75% of the appraised value of the property then the lender will have to put down the remaining 25% amount towards a down payment.
The interest rates depend upon the LTV ratio, higher the LTV ratio means high risk for lenders and higher interest rates for investors. A typical hard money lender will approve a loan with an LTV ratio of 50% to 70% of the loan amount. The borrower will have to put the remaining amount towards the down payment. Hard money lenders generally require a borrower to put down at least 10% to 50% of the loan amount as a down payment. Whereas conventional loans offer up to 80% LTV ratio and the down payment ranges between 3% to 20% of the loan amount.
Why Do Hard Money Lenders Require a Down Payment?
The major reason hard money lenders require a down payment is to lower their risk in lending a real estate investor. Hard money lenders look beyond a borrower’s creditworthiness and provide loans solely on the asset on offer as collateral. In this situation, the lender will have to ensure that the loan they are lending to an investor is secured. The down payment is additional loan security apart from the collateral.
The actual funds in a hard money loan are primarily provided by individuals or a group of private investors. So the lender also has to make sure that they recover the loan amount and the investment proves to be profitable. In this case, the lender will have to determine the ability of an investor to repay the loan.
If you are an investor in need of quick money to invest in real estate, hard money loans are the best funding source for you. But to acquire a hard money loan you’ll have to present the deal efficiently, describe the potential of the property, and most importantly be ready to put down some money.
Hard money lenders require fewer documents and have a simple underwriting process, unlike conventional loans’ complex and lengthy loan process. Conventional loans verify every single income source, funds, and asset of yours to ensure an investor can pay off the loan. Hard money loans are specifically designed while keeping the investor in mind. Hard money loans fill the need for quick funds to invest in real estate.
All of this is based on the potential value your property can achieve in the real estate market. Hard money lenders look past your credit score and provide funds to investors who have the ability to take up a project and execute it efficiently. Hard money lenders are more like your business partner and expect an investor to share the monetary risk involved in a real estate investment project. This is why the down payment is necessary for a lender to ensure that the borrower is worth lending a loan. More importantly, the hard money lenders want an investor to succeed using their funds; this creates scope for a repeat customer and builds a long-term relationship to make the best of an investment opportunity.
The Bottom Line
The down payment on a hard money loan is charged to make sure the borrower is serious regarding their investment project and is ready to walk the talk. Hard money lenders make sure the borrower is willing to share a part of the risk involved in the project in order to minimize their risk of lending.
If you are an investor looking for the best funding source to invest in real estate; your search ends here. 14th Street Capital provides hassle-free hard money loans with less qualification and minimal documents. Investors can easily apply for a hard money loan and avail flexible terms.