Fix-and-flip mortgages have gained popularity with real estate investors. Estimates in recent years show that about 7% to 10% of all U.S. residential-property sales are for business-purpose investments. These transactions typically involve single-family homes.
Many real estate investors turn to hard money loans to fund their residential projects. These are loans funded by private investors in which the property acts as collateral, and they are commonly referred to as asset-based loans.
There are several significant benefits for clients who use a hard money loan to finance their next residential-property purchase. That said, however, it’s important to understand how these mortgages are used and what differentiates them from other types of lending. Hard money loans are primarily used to finance fix-and-flip projects in which the investor purchases a home with the goal of renovating it and reselling it for a profit.
This avenue of real estate investing requires a lot of work but also holds the potential for strong returns. Mortgage originators should discover the many benefits of hard money loans and how they can apply to a client’s investment project.
Primary advantages
One of the key benefits associated with hard money loans is speed. Because these lenders are mainly focused on the collateral and have fewer restrictions than banks, they are able to close loans faster. Traditional loans can take more than a month to secure, but a hard money loan can be approved and funded in as little as a week.
This is highly advantageous to borrowers who need funding quickly. Time is of the essence for many investors, particularly in markets that are highly competitive. Using this type of mortgage can be a card up the investor’s sleeve that gives them the edge over competing buyers.
Second, having a hard money lender in your corner gives the borrower more purchasing power. This is important when the time to make an offer arrives. For sellers, offers accompanied by a hard money loan are an indication of money already in hand. This purchase power is particularly valuable because some buyers lose their financing during the escrow process, costing them the property before the deal is done. Conversely, hard money loans are rarely pulled during escrow, making them a more reliable source of funding.
Some hard money lenders provide instant proof of funds that can accompany your client’s offer and add weight to it. A proof-of-funds letter is effectively a document showing that the buyer has the cash available to close the deal. Bear in mind that this is different from a preapproval letter, which states the lender’s commitment to lend. Some lenders offer online access to proof-of-funds letters.
Additional leverage
Hard money loans hold another significant benefit for borrowers by offering higher amounts of leverage. This type of funding gives the investor more cash for a downpayment and closing costs without the use of personal funds. The main principle behind leverage in real estate is to use external funds (such as a mortgage) to increase your return on investment while using as little of your own capital as possible.
Not only does this allow the borrower to purchase properties that are normally out of their price range, it also helps them to spread out their investments across multiple properties. With a hard money loan, the investor does not have to be limited to a single residential property, which substantially opens up their investment options. Because these lenders are asset-based, there is more flexibility for borrowers regarding loan terms, too.
Asset-based loans are primarily based on the collateral rather than the borrower. Although hard money lenders often check a borrower’s credit score, as well as the status of any previous foreclosures or bankruptcies, there is typically no calculation of the debt-to-income ratio across all of the borrower’s assets and obligations.
Post-pandemic market
Considering the economic repercussions of the COVID-19 pandemic, it’s a natural question to ask how hard money loans are functioning during the health crisis. After all, real estate markets came to a near standstill during the nationwide shutdown.
Like the rest of the mortgage industry, hard money lenders have been rapidly introducing new solutions in order to operate while flattening the infection curve. One such solution is to go exclusively digital: Hard money lenders have increasingly moved online to create new avenues of funding.
The major difference for these lenders prior to and after the pandemic involves their loan products. Fix-and-flip mortgages have remained unaffected, apart from slight increases in interest rates and origination fees, while mortgages with longer terms (such as 30-year rental loans) have been temporarily suspended by some lenders. These suspensions are due to the restrictions on certain loans by wholesale lenders in recent months.
Hard money lenders have responded in other ways by offering online loan applications, virtual walk-throughs and contactless closings. Even though the U.S. economy has been heavily affected during the past several months, real estate markets have remained steadfast and the number of asset-based mortgages is steadily increasing, albeit with more stringent requirements.
Although real estate remains a largely traditional industry, these changing circumstances have fueled a renewed drive to integrate new technologies and future-proof current processes. Despite the challenges posed by the coronavirus pandemic, hard money lenders have reopened their doors and are funding new deals with upgraded loan products.
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There are many distinct benefits in using a hard money loan to fund a residential fix-and-flip project. Hard money lenders provide funds faster and more efficiently than traditional lenders while giving the buyer more leverage.
Keep in mind that this type of financing may not be the best fit for your client’s project and is not suitable when purchasing a primary residence. But with the mortgage industry as a whole looking to the future, hard money lenders are launching online solutions to make this type of lending more efficient than ever before. ●
