Hard money loans have become a popular choice amongst real estate investors to raise quick capital. The flexible terms and shorter approval time has made investing in real estate more convenient.
The US asset-based lending has an estimated market size of over $465 billion. This signifies the growing demand for lenders that provide asset-based hard money loans.
Most of the hard money loans are provided by individuals or a group of private investors, unlike conventional loans where a bank or financial institute provides funds to a borrower. Because of the increased popularity and lucrative investment opportunities, there has been a spike in the number of hard money lenders.
As there are fewer regulations in hard money lending and the lender is the supreme authority that defines the loan terms, some lenders might take advantage of the borrower’s situation. Borrowers must be able to look for the red flags in a hard money loan to make sure they land a good deal.
What Red Flags to Look for in a Hard Money Loan?
Every borrower needs to understand what kind of deal they are getting into. Borrowers must observe the warning signs and identify the following red flags in a hard money loan.
1. Low interest rates
To increase your interest in them, a lender will offer lower interest rates. The average interest rate for hard money loans can range between 8% to 15%. If a hard money lender is offering interest rates that are much lower than this range, it should raise a red flag. For example, 5 percent interest rates on a hard money loan should be a red flag for borrowers and you must not agree to lock a deal. Comparing and verifying the average rates before making a deal is a must before taking a hard money loan.
2. Bait and switch
A borrower needs to build capital in a short period to purchase lucrative real estate. Taking advantage of the borrower’s limited time frame to secure funds, a lender will offer very low-interest rates (usually at or below 5%) and attractive terms to lock the deal with them. Then at the time of funding the loan, the lender will change the terms of the loan at the last minute leaving no option to a borrower than accepting the unfavorable terms.
3. Advanced fees
If a hard money lender asks for any kind of advanced fees or demands large upfront fees like $5000 is a red flag for you to back out of the deal. Upfront fees may vary with the total loan amount; the average upfront fees can be 1% to 3% of the loan and in some cases may go up to 10%.
These types of lenders demand advanced payments using terms like application fees or processing fees to provide you a loan quickly. Once a borrower makes any payment in advance the lender gets vanished with your money. So, borrowers are advised to stay away from lenders who ask or demand above-average upfront fees or any kind of cash in advance.
PRO TIP: Never send funds directly to anyone rather than the title company. The Title Company ensures the proper distribution of the funds and makes sure every transaction is made as per the real estate laws.
4. High loan to value ratio
Hard money lenders use the loan-to-value ratio to determine the risk in lending a borrower. The higher the LTV ratio the higher the risk of lending as the lender will be unable to recover their money by selling the property.
Legitimate Hard money lenders follow predefined guidelines and consider the credit score, loan-to-value ratio, and assets. Some lenders choose to lend primarily on the equity built upon a property, while others look for an asset to be used as collateral for lending a hard money loan. The crucial factor here is the offered loan-to-value ratio. The average loan-to-value (LTV) ratio offered by most of the hard money lenders averages between 50% to 70%, anyone offering more than that is a red flag in hard money loans.
5. No down payment policy
Another red flag in hard money loans is that there is no requirement to pay a down payment for a borrower to obtain a loan, which is unusual. Typically, hard money lenders require 10% to 50% of the loan amount towards a down payment to make sure a borrower has skin in the game and is motivated to repay the loan. There is very little scope for a hard money lender to approve a loan without any down payment upfront. So if a lender is offering you a hard money loan without any down payment, you should avoid them.
6. Confusing terms
There are chances of some hard money lenders intentionally creating terms that are confusing for a borrower. In this way, they take advantage of the borrower’s urgency to get a hard money loan and create an agreement with terms that may prove to be problematic later. So, if you find an agreement that has confusing terms like no collateral requirement, no down payment, the fee structure is not defined, not mentioning the underwriting fees is a major red flag. Even if the loan application form has too many spelling mistakes, grammatical errors, or unclear instructions it is also a red flag for a borrower.
7. Lack of a legit website
Most of the reputed hard money lenders have official websites that provide detailed information about the loans they offer, the lending process, costs of loans, business addresses, etc. In this case, an illegitimate hard money lender will have less online presence, which is a red flag.
8. Absence of a license
Hard money lenders are generally regulated by the Department of the Real-estate of the respective state they operate from. At least one person involved in hard money lending is required to have a valid real estate broker license. A hard money lender which is unable to produce a license or is unlicensed is a big red flag for borrowers to look for.
9. Failure to share the paperwork
Another common red flag to look out for in a hard money lender is that they are unwilling to share all the paperwork involved in the deal. The paperwork or the documents related to hard money loans are important to establish transparency in the deal. A lender unable to share the related paperwork can be considered an illegitimate one.
10. Lender fails to provide answers
A legit hard money lender will guide you through the whole process. They will clear all your doubts and answer every question related to the hard money loan they want to opt for. Any lender that fails to answer your questions and unable to clear your doubts is just fooling around with you and can be considered a red flag.
11. Absence of a property evaluation
Hard money loans are primarily provided on the value of the property on offer as collateral. A legitimate hard money lender will first evaluate the value of a property in order to determine the loan amount. A lender will himself visit the property for general assessment or hire a professional appraiser to evaluate the property. But, if a lender provides loan approval without the evaluation of a property, it is a red flag in hard money loans. Such lenders should be avoided by a borrower.
12. Lack of references
A hard money lender unable to provide references to a borrower can be a red flag in hard money loans. An authentic hard money lender will proactively provide references of investors who acquired funding from them. This allows a borrower to verify the services provided by a lender before making a deal.
How to Identify A Reliable Hard Money Lender
Now that you have a better understanding of recognizing the red flags related to hard money loans, you can minimize the risks related to hard money loans and lenders. This will allow a borrower to identify a legitimate hard money lender and avoid the imposers. There are some factors to look for in a good hard money lender, such as
Has a good reputation
A hard money lender that has a great reputation in terms of hard money lending can be a better choice for borrowers. A reputation is built over time and is based on the experience of an individual with the lender. You can perform a simple survey in your network and see how many investors recommend the same lender. This will allow an investor to determine a good hard money lender to fund their investment project.
Has multiple references
A good hard money lender will have multiple references to back them. Investors who have already taken funds from a lender and had a good experience dealing with them will surely recommend their name. A borrower can also verify the references provided by the hard money lender to make a better choice.
Positive Reviews and testimonials
Another way to identify a good hard money lender is to look for reviews and testimonials on online listings and the lender’s official website. Investors tend to review a lender’s services publicly when they are truly happy with the services provided. A borrower can determine the number of positive reviews as well as the negative ones to determine if a lender is good to deal with.
Provides complete assistance
A true hard money lender is the one who cares about the success of your real estate investment project and lends according to it. A good hard money lender will sit with you and provide a step-by-step guide towards forming a deal that benefits both of you. They will provide complete assistance through the entire loan process, from approval to closing.
Takeaways
To get the best deal, a borrower must be able to look for the red flags in a hard money loan. A borrower should avoid lenders that ask for direct cash or demand large upfront fees. The most important thing is to choose the legitimate hard money lender that will offer the best deals for your investment project.
Rated amongst the best hard money lenders for real estate investors, 14th Street Capital is the best funding source for your real estate investment project. We provide hassle-free hard money loans with flexible terms and short funding timelines.