Fix, Flip, and Flourish: How Hard Money Fuels Fix-and-Flip Profits
Are you interested in starting a fix-and-flip business? Do you need a guide on how hard money can help you transform worn-out properties into lucrative assets?
In this article, fix, flip, and Flourish: How Hard Money Fuels Fix and Flip Profits, we will explore how this financing type is vital to many real estate success stories.
From funding unconventional projects to helping bad-credit investors turn a profit, we’ll explore how hard money is the perfect financial backing to renovate a fixer-upper.
This post is ideal for seasoned investors and those new to the game as it tackles the concept of asset-based financing in simple terms, how it differs from traditional loans, and the eligibility requirements.
We’ll also outline the pros and cons of hard money loans to help investors ensure this funding type with their financial goals and risk tolerance.
Now, let’s dive straight in:
What is Asset-Based Financing
Asset-based financing is a funding method where a borrower secures a loan by pledging specific assets as collateral. Thus, instead of primarily relying on the borrower’s creditworthiness, the focus is on the value of the assets.
In other words, assets such as real estate, inventory, accounts receivable, equipment, or other valuable possessions act as security for the loan.
The lender typically hires an appraiser to determine the worth of the borrower’s collateral and extends a loan based on a percentage of the value.
If the borrower fails to repay, the lender has the right to seize and sell the collateral to recover the outstanding amount.
Businesses with valuable assets often utilize this type of financing but may face challenges in obtaining traditional loans.
Asset-based financing provides a flexible and collateral-focused approach, allowing companies and individuals to access capital for various needs, such as expansion, working capital, or restructuring. Hard money loans are a type of asset-based financing where investors typically use equity or properties as collateral.
How do Hard Money Loans Differ from Traditional Loans?
From collateral and speed to suitability for specific investment projects, hard money loans differ from traditional loans in several key ways:
1. Collateral Focus
Hard money loans are asset-based, typically secured by real estate or other tangible assets. The more value your asset has, the more leverage you have when negotiating with a hard money lender.
Private lenders are more concerned about having substantial backing if the borrower fails to repay the loan.
Traditional loans, on the other hand, often rely more heavily on the borrower’s creditworthiness and financial history.
For example, when applying for a conventional mortgage from a bank, you must provide a long list of documents, perhaps even apply for a pre-qualifying loan.
The bank will now consider all those metrics to determine whether or not you’re eligible for a loan and, if so, how much.
2. Speed and Flexibility
Another difference between both options is that hard money loans are known for their quicker approval and funding process. Within 3 days to 2 weeks, investors can secure a hard money loan, which can help them capitalize on time-sensitive projects like real estate fix-and-flip.
Moreover, hard money lenders treat borrowers on a case-by-case basis and are more willing to negotiate terms. Thus, with a valuable asset, a convincing exit strategy, or a knack for negotiation, you could quickly get approval for a loan with excellent terms.
On the flip side, traditional loans involve a more prolonged approval process. Since they have more rigid regulations, there is a need for multiple background checks, comprehensive credit checks, and documentation requirements. These make the approval process longer and averages around 4 weeks.
3. Interest Rates and Terms
Traditional loans typically have a lower interest rate than hard money loans. Their thorough background check means borrowers are low risk and can afford to provide extensive repayment periods at a low rate.
In contrast, private lenders must consider the higher risk they face by placing more value on collateral than on the borrower’s credit history.
Even when investors cannot fulfill their requirements, leading to asset seizure, lenders still have to undertake the resale process, which can be time and money-consuming.
Since default rates are often higher than conventional loans, they must counterbalance the downsides with a higher interest rate and shorter loan term. However, you can secure better interest rates and terms by identifying potential lenders matching your goals.
4. Purpose
Finally, hard money loans are commonly used for real estate investment projects, especially fix-and-flip scenarios, where quick access to funds is crucial. They’re also widely used for commercial properties that have a relatively quick turnaround.
Traditional loans cater to various purposes, including personal loans and business expansion. They’re popular amongst investors looking to secure a residential home for themselves.
There is often no rush to pay off the loan and move to the next project, making the long-term financing of traditional loans a benefit.
Eligibility Requirements for Hard Money Loan Application
Eligibility requirements for hard money loan applications can vary among lenders, but here are common factors considered:
1. Asset Value
As we’ve previously highlighted, hard money loans emphasize collateral. Thus, lenders have assessed the value and condition of the property.
The asset’s value plays a significant role in determining loan eligibility and whether it is sufficient to use as security for your prospective project.
2. Loan-to-Value Ratio (LTV)
During the hard money loan application process, lenders often have maximum LTV ratios, representing the percentage of the property’s value they can borrow. A lower LTV means that a borrower’s debt is significantly less than the home’s value on resale.
In other words, it is an investment likely to yield significant profit, increasing the borrower’s eligibility and improving loan terms.
3. Exit Strategy
Lenders want assurance that borrowers have a viable exit strategy, especially in fix-and-flip scenarios. Whether selling the property or refinancing with a traditional loan, you have to demonstrate that you can repay the hard money loan.
As a result, borrowers who have experience in real estate or a related field are more eligible.
4. Credit History
While hard money loans are asset-based, some lenders may still consider the borrower’s credit history. A strong credit profile can positively impact terms and approval, but it’s less crucial than a factor like collateral.
5. Down Payment
Sometimes lenders require a significant down payment. This reassurance emphasizes the borrower’s commitment and signals to the lender that the loan is less risky.
Pros and Cons of Using Hard Money Loans in 2024
Utilizing hard money loans in 2024 can be advantageous for quick and specific real estate investment needs. However, its potential drawbacks could burden borrowers with higher costs and shorter terms. Let’s look at the pros and cons in detail below:
Pros of Using Hard Money Loans in [2024]
#. Quick Funding
Seize time-sensitive opportunities by opting for a hard money loan. House flipping is a time-conscious business that sometimes requires operating within a specific window to maximize profit.
This financing option is popular amongst house flippers because hard money loans are known for their speedy approval and funding process. In other words, investors can secure capital for their projects within days of applying and getting started.
As a result, house flippers can easily take advantage of prime property on sale, quickly turn a profit, and pay off their loan in a few months.
#. Asset-Based Approval
Improve your chances of getting a loan by offering valuable collateral. Hard money loans are a standard solution for investors with a low credit score because lenders aren’t particular about such metrics.
Unlike a traditional mortgage, hard money lenders are more concerned with the value of the property or asset you use as collateral. As a result, hard money loans are more accessible to borrowers with less-than-perfect credit.
#. Flexibility
Another benefit of a hard money loan is that it offers investors more flexibility. Since hard money lenders do not have a rigid underwriting process, they are more likely to negotiate terms on a case-by-case basis.
For example, if you’re offering a property with more value than your prospective project as collateral, you can ask for a more favorable loan term. You can request a smaller downpayment, lower interest rate, or longer timeline.
Thus, this financing option accommodates various property types and unique projects such as fix-and-flip ventures.
#. Higher Approval Amount
Invest in your dream property by opting for a hard money loan. Traditional lending processes often involve a pre-qualification process that determines your loan amount.
Investors can only then finance projects at or below that price, limiting what type of properties they can invest in. On the other hand, hard money loans prioritize the LTV ratio of a property and approval financing based on those figures.
Cons of Using Hard Money Loans in [2024]
#. High-Interest Rates
Hard money loans typically carry higher interest rates than traditional loans, increasing the overall cost of borrowing. To illustrate this point, the average interest rate for a hard money loan is typically 10 – 18%.
That is significantly higher than a conventional loan, which averages around 7%. As a result, the interest investors have to pay compared to the capital they borrow is often higher. Not to mention other charges such as point and origination fees, which drive up the total cost.
#. Short-Term Nature
Make plans to promptly repay when seeking a hard money loan because they often have a shorter repayment term. Short-term loans usually pose a challenge for investors who do not plan properly or have to deal with unexpected problems.
For example, if an investor cannot sell a property within the expected timeframe due to market fluctuations or delays or the part of the contractor leading to a longer project timeline, the investor would still need to meet their monthly loan payments.
Thus, meeting those requirements can cause the borrower to risk missing deadlines and paying late fees.
#. Asset at Risk
Asset seizure is a real risk investors take when opting for a hard money loan. Borrowers who fail to repay their loan on time risk relinquishing their assets.
After all, most lenders require a property of equal value to act as collateral, leaving the investor with less bargaining power.
#. Limited Regulatory Protection
While fewer requirements mean borrowers can secure approval quicker, the trade-off is that they have to endure less protection.
Hard money lenders have fewer regulations to follow compared to their traditional counterparts, so borrowers have more exposure to pitfalls and scammers.
Hence, it puts the burden of finding a straightforward and reliable lender on the investor to avoid signing a bad contract and losing money.
Conclusion
In conclusion, with their asset-based focus, hard money loans have emerged as a crucial tool for investors to fix, flip, and flourish.
As a quick funding solution that offers flexibility and customizable terms, they’re attractive to borrowers, especially in time-sensitive scenarios like fix-and-flip projects.
However, this convenience comes at a cost. The higher interest rates, short-term nature, and the risk of asset seizure can undermine an investor’s plan.
Thus, creating a strategic approach before applying for a loan would be wise. As with any financial decision, careful consideration of individual circumstances can influence your approval. Your asset value, exit strategy, and the LTV ratio significantly determine your eligibility.
Whether you’re a seasoned investor or a newcomer, hard money loans offer a pathway to house-flipping success.
Understanding the eligibility criteria, weighing the pros and cons, and having a robust exit strategy can help you leverage the benefits of a hard money loan while mitigating its potential pitfalls.
Author Bio
Patrick Freeze is a licensed real estate broker with over a decade of experience in real estate and property management. He graduated from Dickinson College before starting Bay Property Management Group, which specializes in a wide range of properties, using experience to help property ownership become the profitable experience it should be.
