5 Red Flags To Look Out For With Every Hard Money Deal
By JD Esajian on October 18, 2017
Every real estate investor should have access to hard money. Even if you don’t think you will need it you never know when the right deal will come along. There are more hard money lenders today then ever before. In the past, there may have been one local hard money lender who was only used to stop a foreclosure or for other unique circumstances. It is not uncommon to have three or four hard money lenders in your local area. As important as they can be you need to know exactly what you are getting into.
With increased popularity there has also been an increase in hard money scams. By the time these people are done you will not know what hit you and you will be out thousands of dollars. Before you blindly dive into an agreement you need to take a minute and know exactly what you are getting into. Here are five potential warning flags from hard money lenders.
- High loan to values. Prior to looking for a new lender you should take some time to understand the process. Just because you want cash doesn’t mean you will get it. Hard money lenders have specific guidelines based on credit score, loan to value and assets. Some lend strictly based on the equity of the property and others require a minimum credit score and assets. One item that is almost fairly universal is the maximum allowable loan to value (LTV). Most hard money lenders will not lend over 70% of the after-repair value, with some as low as 65%. If a lender is offering you 80%, or higher, it should be an immediate red flag. Hard money lenders are in the business of making a sure profit and aren’t about to speculate, especially in a new relationship. If the loan to value to higher than 70% it should give you pause as to their intentions.
- Upfront fees. The best ways to find hard money lenders are through networking events and personal referrals. Once you start looking online you never know what you will find. A new hard money lender may offer you the sun, moon and stars but many times they are too good to be true. Even if you spent weeks talking and going back and forth the minute they ask for any money upfront you need to walk away. Any real hard money lender will ask for fees to be received at the closing. They may want a credit pull or an inspection but those are third party fees that wouldn’t go to them. If they ask for any cash or anything sent western union you know they aren’t legitimate. They will tell you that their time is worth money and they need to see if you are a real investor but don’t fall for it. Upfront fees are one thing, but direct cash payments are another.
- Undefined rates. The three basic questions for any hard money lender should be: what is the loan to value, what are the fees and what is the interest rate? If a hard money lender has any trouble immediately answering these, you should find someone else. It is common knowledge in the industry that the going rate for a hard money loan is anywhere from 12 to 16 percent. This can vary based on the specific borrower and the property but those are the averages. If there is any type of a teaser rate offered in the single digits you should be skeptical. A hard money lender offering you traditional lender rates is a red flag. Hard money lenders offer a specific niche service that you can’t find with a local bank. Because of this they are compensated for their risk. You need to accept that the interest rates will be higher and if the lender is offering 7 or 8% you should feel something isn’t right.
- Confusing terms. One of the advantages of hard money loans should be their ease and simplicity. The lender usually has a straightforward set of terms, fees and rates. If the language of the agreement is difficult to understand and has confusing terms you need to question it. A professional has no problem letting an attorney review the contract or allowing a day to read things through. Asking for a signature within the hour is a sign that something may not be right. The goal of a hard money lender isn’t to trick someone into giving away a bigger piece of the pie, it should be to build a profitable relationship for years to come. Anything confusing on the contract or agreement statement must be questioned.
- Generic items in your favor. If a hard money lender is giving away too much of the farm you know something isn’t right. It usually takes a lender several deals before they feel a level of security. Even after a handful of deals they still tilt the lion share of the profits and terms in their favor. When you work with a new lender for the first time you should expect to get the short end of the stick. If the opposite is the case a red flag should be raised. They are not trying to generate new business they are trying to scam you. Hard money lenders are always in business to make a profit and anything less must get your attention.
The majority of hard money lenders are hardworking, reputable people you want on your side. Like any other business all it takes is a few bad apples to ruin it for everyone else. With an increase in hard money lenders you can expect an increase in potential scammers. Keep your eyes open for these five items.