So you’re thinking about investing in hard money lending…
Excellent! I believe that’s the “secret” way to true and lasting wealth. It’s not something you hear talked about all the time, probably because usually you need a good amount of money to get started (but not always!).
So I’ll give you the ins and outs today of everything I know about it. But first, let me tell you how and why I get started!
How I Started in Hard Money Lending
About 15 years ago, I was doing well as a real estate investor. My forte was certainly fix & flips, but I did a little bit of everything: duplexes, commercial, buy & hold, and tons of others.
During these years of super-active investing, I met a guy named Dan. He was a well-off guy who wanted to do something more with his money than the traditional “Wall Street” tactics of investing. So he financed a few deals for me, and we both made nice returns on a few deals.
Then one day he comes to me…
He says, “Ryan, I’ve been testing you with these past few deals. I see that you work hard and you know how to get great returns on my money. So here’s XYZ dollars, and I want you to figure out how to invest it.”
If you can guess “XYZ” was a TON of money. Like I couldn’t believe how much money he wanted me to help him invest!
And I knew exactly what I wanted to do with his money.
Hard money lending.
Eventually that turned into my company, The Investor's Edge. On the front end, we provide loans to fix & flippers. On the back end are the private lenders who fund these deals.
Who is Hard Money Lending For?
Typically, hard money lending is perfect for someone who’s had a lucrative career and is now ready for their money to go to work for them in a passive, secure way…and of course with high returns!
Many people I talk to about lending are frustrated. They’ve made a lot of money, but they’re not getting the returns they thought they should get. Their retirement might not be looking as close as they though because their money is stuck earning 6%. Other people who get into hard money lending are younger professionals who are making good money, but have to work really hard for it. They don’t mind hard work, but now as their family gets older, their priorities change. They want to be there for their children or enjoy more time doing what they want to do. When they start earning 15% with hard money lending, it opens a whole new world to them.
For me, I hate traditional models of investing money. I don’t like ceding control to others. I don’t like giving my money to Wall Street commission salesmen. And worst of all, I can’t stand to have my money sitting in a bank account or to have it earning very low returns. I’ve worked hard for it, and I know there are better ways to invest it. That’s why I’m the world’s biggest advocate of hard money lending. I’ll get to my story in a second…
Private Money vs Hard Money
Just a point of house-keeping before we move forward.
Hard money usually comes from a banking institution, basically a company. They have CEO, managers, and employees. They have marketing departments and loan officers. This means that they’ll have set loan programs with set criteria in order to fund deals. For example, they may say that they’ll only lend up to 70% of the after repair value, and then have set points/origination based on credit score, experience, and/or the riskiness of the deal.
Private money is a much looser term. It refers to a person or a group of people who like to fund real estate transactions and usually negotiate terms on each deal. They take each deal on a case-by-case basis, deciding not only if it’s a good deal to pursue, but also how much to lend and what interest rates, points, origination, and more will be built into the deal.
In this post, I’ll be talking about both, somewhat interchangeably. I’m mostly interested in talking about funding real estate deals in general.
Why Hard Money and Not a Conventional Loan?
So…why does hard money exist? Why would a borrower go to a hard money lender that may require 15% interest on top of origination?
Well first of all, conventional banks aren’t going to fund these types of deals! Think about it like this:
If a bank allowed you to get a loan at a 4% interest rate, as if you were buying your own residence, but then you did a fix & flip and paid off that loan in 6 months, then the bank only gets interest for half a year! There just isn’t enough profit there to be interesting. Banks want you in the loan for years and years and years…which is why they look at your ability to pay off the loan over the long haul as the main pre-qualification requirement.
Also, banks have much stricter requirements about the condition of the property they’ll lend on. There’s something called FHA guidelines, which basically means that the house must be up to code. For example, if there are exposed wires in the house, it won’t pass inspection and you can’t get a traditional mortgage on that property until it’s fixed.
Many of the houses that real estate investors look to flip don’t pass FHA guidelines. They’re homes that are in disrepair. Many times, these people need money quickly and they don’t have the time or the cash on hand to fix the issues and then wait for someone to come along with an offer from a conventional bank. As a hard money lender, you can lend to an investor on whatever properties you want, and can have them funded much quicker than a conventional bank.
What is the Borrower Using the Money For?
So you’re lending money…for what exactly?
For a real estate investor to fix & flip a property!
So…you and the person you lend to are investors? Basically, yes.
Here are some common types of deals that real estate investors will be using your money for:
Residential Fix & Flips
This is the most common type of real estate investment (I’m not counting just buying a house and living there…even though that could technically be considered an investment). Hundreds of thousands of homes are fixed up and flipped every year.
What happens is that a real estate investor goes out and finds properties at a discount. They’re looking for houses where the owner has a reason to want to sell the property for cheaper than it probably should sell. There are lots of reasons why a property owner may want to sell a property at a discount…here are a few:
- A rental property owner finds out that his property has been trashed. He’s frustrated and wants to move on, partially because he doesn’t have the cash on hand to fix up the property.
- 3 siblings inherit a property from their father who had been too old to keep the home in good condition. These siblings want to sell the house to get their money and move along.
- An elderly man needs to move into a nursing home, but has a house that he’d like to sell quickly. He needs to pay for the expensive nursing home, and it’s quicker to sell it to a real estate investor with money ready to go than a to someone getting funding from a conventional bank that can take months.
- A general contractor botches a repair job badly on a house. It’s not in any shape to list on the MLS, but the owner doesn’t have the money to fix it up.
I’ve flipped deals, and lent money to other investors who’ve done all of these types of deals I’ve mentioned. There are many, many more cases than what I’ve mentioned here as well.
The other piece of the puzzle to understand is that the seller must have equity in their house. The fix & flipper needs to get the property at a discount to make money, but if the owner has too little equity, this discounted price would result in the seller still owing money. They will never agree to that.
Here’s what I mean:
If the owner owes $200k on their property, and a real estate investor offers $180k, that means the seller would still owe $20k on a property that they don’t even own anymore! That’s why I always look for (and teach my students to find) properties with at least $50k – $100k in equity.
If you’re going to begin investing in hard money lending, you’ll likely be coming across investors who’re looking to do a BRRR deal! These are investors who want to Buy, Rehab, Rent, and Refinance the property, and this strategy is growing in popularity lately. The big benefit for a real estate investor is to create a higher value property that they can then rent out for higher monthly income!
For the real estate investor, it starts out the same as a fix & flip. They’ll be looking for discounted properties, putting them under contract, get funding (from you, in this scenario), and then rehab the property. Next step is that they’ll go find a renter, and then refinance the loan into a traditional 30-year mortgage. There are banks that don’t like to take on someone without rental experience and may not have great credit, so sometimes the real estate investor hits a snag with this step. However already have a renter in the property helps. At The Investor's Edge, we’ve partnered up with banks that will refinance these loans to borrowers without rental experience.
So how does this all look for you as the lender?
Relatively the same as a fix & flip. The main difference is that BRRR deals are a little more complicated on the back end with finding a renter and then refinancing the loan (to pay you off). In fact, this extra complication might end up paying you more as the borrower may be in the deal a little longer and owe you more interest. Of course, you’d rather the deal go quickly and smoothly so you can move into another deal, but delays usually end up meaning more money for you. It’s a nice silver lining.
Other Types of Deals
Fix & flips and BRRR on single family homes are certainly very popular (they’re the most popular loans we do), but as a lender, you can lend on whatever you decide to!
This could be new construction, multi-unit properties, townhomes, storage units, parking garages, apartment complexes, mobile homes, and so much more! It really comes down to what you’re comfortable lending money for.
Different Lending Structures
There are plenty of ways that you can invest as a hard money lender, private lender, or even what we call a gap financer. Let’s take a look:
Private Money Lender
This is just you and a fix & flipper, where you lend them the whole amount for the deal. If it’s a $200,000 deal, you’re giving them the whole thing. You make money typically by charging points, interest, and potentially other things like late fees, extensions, etc.
Of course to do this, you’ll need plenty of money stashed aside. For example, to fund deals with us, you have to be an accredited investor. That means you have $1 million net worth, excluding your private residence, or you’ve made $200k ($300k for join income) for each of the past two years and can reasonably assume you’ll continue earning that type of money.
The hardest part of doing this type of deal is that you have to know for yourself if the borrower can keep his end of the bargain. Does he know what he’s doing? Is the deal profitable? Can he manage a rehab project? More on this later.
This is a great option if you’re interested in smaller loans or you’re not an accredited investor.
Let’s say a real estate investor brings a deal to a hard money lender. It’s a pretty good deal, but the real estate investor needs $10,000 more cash-to-close to complete the deal. What can he do?
He needs to get gap financing! This is where someone like you can come in and bring that $10,000 to complete the deal.
A partnership is usually a one-time deal where you join forces with someone willing to do the actual work of completing the deal. The structure of partnerships vary, but you’ll be providing the money, and in return you’ll make either a percentage of the profits, or you can charge interest on the money. In a partnership, you’re more likely to see a profit split.
This is basically a more formalized partnership. In this structure, you’ll set up a company jointly with the plan to work together on lots of deals. You’ll likely split the profit on any deals. And as a side note, since you are the one taking on all the risk, at first you might be able to get a little higher percentage of the profit, perhaps 60-40.
Crowdfunded Hard Money Loans
This one’s a bit more out there, but more accessible to more people!
You’ve probably seen apps out there like Fundrise where you can buy a piece of a property instead of the whole thing. If you buy 1/100th of a rental unit, you get 1/100th of the rental profits…simple as that!
While it’s less common, there are companies out there that work on the lending side of things. You don’t have to fund an entire deal, but if the borrower is paying 18% interest, you can get 18% interest on the money that you’ve lent.
While services like these aren’t everywhere, one way to do this manually is to join an investment group, where you have say 10 people, and each one puts in 1/10th of the cost of the deal. These types of opportunities are why I recommend that everyone interested in any type of real estate investing or lending should constantly be networking!
Partner With a Company
One interesting thing about hard money lenders is that many of them fund deals through private lenders on the back end! In other words, the hard money lender acts as the middleman between the borrower and the individual who’s lending money on the back end.
Often, those two parties don’t interact. The hard money lender vets the borrower, vets the deal itself, sets the terms of the deal (origination, interest, etc.), and then the private lenders on the back end decide if they want to pick up the deal or not.
This is the ultimate in passive investing. If you trust the company, you can do very little or no work (just say “yes” to a deal and wire the money) and be getting better returns than 99% of people even know exist.
Getting Started in Hard Money Lending
Getting into lending can be tricky as there’s A LOT to know! If you’re looking to do one-on-one lending, you’ll want to understand:
- How to vet borrowers – Has he/she done deals before? Don’t assume because he has experience in other aspects of real estate that he can know how to pull off a fix & flip.
- How to vet the deal itself – do you know how to calculate after repair value and rehab costs?
- Put together legal documents – there’s so much more paperwork than you think…does the deal structure you’re putting together make sense for you and is it legally binding?
- Can you attract investors – If you’re going to do this regularly, you’ll need to be constantly networking, running ads, attending conferences/groups/meetings, and more. Otherwise, are you just hoping people will approach you? Not likely.
- Understand ALL the steps – In addition to what I’ve mentioned, you’ll also want to understand how each step of a fix & flip works. Your money is on the line, and if you don’t know enough to know if the borrower is doing a poor job, than you’re gambling with your money. Learn things like:
- How to determine after repair value
- What types of properties make good fix & flips
- How to market to property owners
- How to negotiate with the seller
- How to estimate rehab costs
- How to handle inspections
- How to find & manage a general contractor
- How and what should you rehab in the property
- How to sell the property fast after the rehab
In my mind, you should know enough that you could do a fix & flip yourself, but you don’t because you’d rather enjoy the returns without having to do the hands-on work yourself…hopefully.
Also, if you know all these steps, then if the worse-case scenario happens and the borrower walks away from the deal before it’s finished, you’ll know enough to finish the project yourself and maximize your profit.
Partnering With a Company
Alright, I’m guessing that you’re seeing that the best way to get into hard money lending or private lending is to work with a company. Any other way, in my opinion, is fraught with too much risk, and frankly still requires a fair amount of work from you in vetting and managing these deals!
Let’s talk about a better way. A way that doesn’t require you to be hands-on every step and yet you’ll still have experienced professionals managing the borrower so you don’t have to worry.
I’m talking about becoming a private lender with The Investor's Edge.
While you must be an accredited investor, here is how the process works for our lenders:
- A real estate investor comes to us, interested in flipping homes.
- They go through a 2-part application process and then a 2-part screening process with my team.
- They pay to join our system and to get access to our potentially 100% financing.
- Inside our system, they get 5 pieces of software, over 100 training videos, contract templates, marketing examples, and more. Everything they could need to find & complete deals.
- Once they find a potential deal, they fill out a loan application and one of our loan advisors reaches out to them.
- If the deal looks good so far, another member of our team will do what’s called a “Desktop Evaluation.” This person will virtually assess the value of the property by analyzing the property itself as well as the surrounding neighborhood and comparable properties.
- If the values still look good, then we send a 3rd party evaluator (or appraiser) out to the property. This is always someone local who knows the area very well.
- We assign a project manager (all of whom are former general contractors) and that PM works with the GC on the project to confirm the rehab bid.
- We get ready to fund the deal! We send an email and a text to our individual private lenders on the back end, and the first one to respond gets to fund the deal.
- The lender makes their money from the interest payments, as well as any late/extensions payments that occur.
- The borrower completes the rehab, usually within 5 months, and pays back the loan along with any other applicable fees.
In other words, the lenders don’t have to do any vetting, evaluating, or even any managing of the deal. If a property needs to be repossessed, we handle finishing the project and selling the property. The lender just has to wire the money and then collect interest payments. Everything is vetted by us.
Of course this has been a big pitch for becoming a hard money lender/private lender with The Investor's Edge, but other companies out there do the same thing. It’s not something you have to do with us. Also doing this by yourself can also mean that you can set different terms. If you want to collect half the profit at the end, you could probably arrange deals like that and likely earn more money, albeit likely to require more hands-on work from you.
All in all, I tell people that there is no better way to invest money.
- It’s passive (especially if you partner with a company to do all the vetting and managing for you)
- It’s more consistent (set interest payments)
- It’s less risky (there’s an asset to back up the loan)
- There are really high returns—in fact, our lenders have historically earned around 18%, with that number going even higher lately.
- Money isn’t tied for a long time. In other investing strategies, you have to keep your money in it for a long time. Think some types of bonds, some real estate transactions, or a retirement account like a 401(k). Most deals are wrapped up in less than 6 months and your money comes back to you.
I can’t stress enough that this is my favorite way to invest. When I was given stewardship over a good chunk of money and told to make it grow, I started a hard money lender.
Are you interested in getting started in hard money lending? Go to our Become A Hard Money Lender Page.