Hard money lending is like other forms of lending in the sense that it comes with pitfalls borrowers should be aware of. As unique as hard money lending is in other ways, its pitfalls can be every bit as disastrous if they aren’t avoided.
What are those pitfalls? Six of them are discussed below. As you read, bear in mind that hard money lenders are private lenders. That means they have a lot more flexibility in how they do business. So some of these pitfalls may or may not apply to any particular hard money scenario.
1. Assuming Everyone Gets Approved
The most common mistake in hard money lending is assuming that everyone gets approved. Nothing could be further from the truth. Actium Lending is a Salt Lake City hard money firm operating in Utah, Idaho, and Colorado. They explain that their firm follows very strict criteria in determining who gets approved and who gets denied. They also say they are not alone.
The idea that everyone gets approved is born out of a misunderstanding that hard money lending is an option of rest resort for people who cannot get traditional bank financing. The assumption is that all these people get the green light from hard money lenders looking to rip them off. Fortunately, neither idea is true.
2. Not Carefully Thinking Through the Loan Amount
Because hard money lending is asset-based, the amount of money a borrower is eligible for is directly related to two things: the size of his down payment and the value of the collateral being offered as security. It is in a borrower’s best interests to carefully evaluate the requested loan amount so as to not over- or underestimate. Finding the sweet spot increases approval chances and puts the borrower in the best financial position.
3. Ignoring Terms and Rates
Ignoring loan terms and rates is another huge mistake. Hard money loans are short term by nature. How short? Your average loan has a term of 6-24 months. As for interest rates, they tend to be several percentage points higher than traditional loans. Borrowers need to be aware of this going in.
4. Expecting a High Loan-to-Value Ratio
A lot of first-time hard money borrowers go into it expecting a fairly high loan-to-value (LTV) ratio. Banks may offer LTVs of 80% or higher. Hard money lenders tend to be closer to 65-75%. Some go as low as 50%. Remember that LTV has a direct impact on borrower down payment.
5. Failing to Formulate an Exit Strategy
Hard money lenders require a reasonable exit strategy before they will approve a loan. Going in without an exit strategy guarantees loan denial. Going in with a questionable strategy makes approval iffy.
6. Waiting Too Long to Apply
Even though hard money lending is known for its speed, it is still possible to wait too long to apply. This pitfall applies mainly to real estate investors working time-sensitive deals. If they cannot meet deadlines, they risk losing what they are working on. So applying for a hard money loan at the earliest possible moment is a wise move.
There are even more pitfalls I cannot get to for lack of space. The six described here are the most important ones to pay attention to.
Whether you are a property investor or a business owner, hard money could prove to be a very valuable tool as you seek to reach your financial goals. Choose your lender wisely. A good hard money lender could become a valuable partner in your financial success.
