Everything You Wanted to Know About Private Money (Hard Money) Loans But Were Afraid to Ask

Hugh Damon in Aloha Shirt

By Hugh C. Damon
Island Capital Funding

Private money or Hard Money is often misunderstood. Many industry professionals know very little about it, and fallacies and misconceptions tend to dominate the collective wisdom.

What is private money used for?

Private money is generally used as a bridge: a way to get from point A to point B. It is generally a short to medium term solution (6 months to two years), and there is always an exit strategy going in. It is used for all types of real estate secured financing: commercial retail, restaurants, hotels/motels, marinas, elder care facilities, industrial, agricultural, raw land, land development, construction, rehab, multi-family, single family homes, and manufactured homes.

What are the interest rates?

Private money rates generally range from 10 to 18%. The rate is determined by looking at a combination of factors: (a) LTV ratio, (b) strength of borrower, (c) condition/desirability of property, (d) actual cash-in or real equity contributed by borrower. Typically our rates fall in the 11-15% range.

What fees are involved?

We charge a loan fee generally equal to 4% to 10% of the gross amount of the loan. We also charge a doc prep fee ($500 or more, depending on the size of the loan), a property inspection fee ($500 or more, depending on the location of the property) The borrower will also be responsible for Escrow, Tile Insurance, Legal documentation fees.
Can the fees be paid from the proceeds of the loan? 

Yes, if there is enough equity in the project. This is frequently the case.

Is there a pre-payment penalty?

We generally have a 75% of the unearned interest of the first year clause for our loans. It means that if a borrower repays a loan in 6 months (on a one year loan), he would owe 75% of the final 6 months interest.

Why would anyone pay those kinds of rates and fees for a loan?

There are many reasons whey a borrower would choose to use private money over a cheaper institutional option. For example, professional real estate investors like to use private money when buying because they are able to make offers which are not constrained by long timelines and numerous rigid conditions. Often times speed is a very significant factor in completing a profitable transaction and in those cases it often makes sense to pay for a short-term private money option rather than loose the deal. Frequently the condition of a property won’t allow for the initial financing with conventional money, and in those cases private money may be used. Often the type of property is a factor: banks don’t like lending on raw land and lots, but private money lenders are more inclined to do so. Cash leverage is another factor. Island Capital Funding, for example, loans based on the true value of a property, not the purchase price, so sometimes we lend 100% of the total acquisition cost for a property. The structure of the deal may be a factor. Most private money lenders allow the buyer to establish their equity through the mechanism of a seller carry back; banks won’t do this. The list goes on and on.

What is the most common use for private money?

Our most common loans are probably construction, rehab, and land development loans.
How fast can private money loans close?

We have been known to close loans in a matter of one or two days, but more typically, you should figure on 1-2 weeks. (Keep in mind that it is only possible for us to move quickly if the borrower, broker and other third parties are moving quickly as well.)

Is an appraisal required?

Some private money lenders require them. We don’t. Evidence of value is a critical part of the private money loan process. However, it is our opinion that a good set of comps is just as effective in establishing value as a good appraisal. Many of our borrowers are professional investors, and we feel that they are qualified to perform the value analysis.

As a mainstream mortgage broker, I don’t see much of this type of thing. Why should I be interested in private money?

To be perfectly frank, it is my belief that mainstream mortgage brokers are being squeezed out of the industry. Lenders are ramping up their operations to better provide online loan sourcing directly to borrowers. We saw a similar thing in the travel industry over the past years. The travel agents that have survived, and even thrived, are the ones who effectively established niches within the industry. It is our belief that the same will be true for mortgage brokers. Plain vanilla loans can be easily processed in an assembly line fashion which easily translates to the world of the novice and a web browser. Niche lending, on the other hand, tends to be a hand-crafting of sorts, and cannot be easily automated. Look at private money. There are no absolute rules. Many factors must be considered in making a decision and frequently those factors are intangible. Ultimately a high degree of thought work and common sense is involved. Private money will always be a people process. So if you tell me, “I am not interested in private money because I don’t do unusual loans,” I say to you, “You might want to reconsider.”

Why do they call it “hard money”?

It is difficult to find an answer to this question. I’ve heard plenty of speculation. Some people say that it’s because the money is used for “hard to do” loans. Others say it is because the loans are “hard to get” or “hard to pay.” It is my belief that it is called hard money because traditionally it has been “real money” in the sense that it is not borrowed. Institutions loan borrowed money, and in this sense they loan “soft money.” However, I must point out that things have changed a bit over the years, and these days a good deal of hard money is in fact borrowed. (I would guess as much as 50 %.)

How do I go about doing a private money loan with Island Capital Funding?

There are basically four steps.

  1. First, run the concept by us. You may call and discuss the loan with us, or you may e-mail a summary. If we like the project concept and feel that the numbers are acceptable, we proceed to the next step.
  2. We review a complete loan packet.
  3. If all this checks out, we ask the borrower for a deposit (generally $500). This should be in the form of a cashier’s check or money order.
  4. If the property checks out, we draw up the documents and close the loan through escrow.

Is the deposit check refundable?

If we close the loan through escrow, the deposit is applied as a credit to the loan fees. If we don’t close the loan because (a) the borrower does not or cannot perform or (b) the project upon inspection is “significantly” different than as represented, we keep the deposit to reimburse us for our costs. Otherwise, if Island Capital Funding fails to perform for any reason, we return the deposit to the borrower.