Avoid a Financial Mistake: 5 Mistakes to Avoid With Hard Money Loans
Seeking out a hard money loan? Avoid a potentially devastating financial mistake by reading these common mistakes to avoid when borrowing hard money!
If you’re looking for a construction loan or want to do some serious renovations, you may need to try and qualify for a hard money loan.
This type of loan is different from the standard mortgage, and it’s quite easy to make a major financial mistake if you don’t understand how these loans work or what to look for.
Before you apply for a hard money loan, read on to learn about five important mistakes to avoid so you can be a savvy borrower and set yourself up for success.
1. You Don’t Give the Correct (or Enough) Information to the Lender
When applying for a hard money loan, lenders will ask for a wide array of your financial and personal information. Depending on the purpose of your loan, you’ll need to submit several different documents to help the lender create a clear financial picture.
Expect to have two or more years’ worth of tax returns available when you apply for the loan. If you’re a business owner, you will likely need to supplement that with a profit and loss statement.
In order for lenders to make an approval decision, they need a true idea of your financial standings. Tax returns and earning statements are the first step toward getting your loan approved.
Ask the lender for a detailed list of the documentation they need. Try to get the list as far in advance as possible so you can start gathering everything together in advance.
Create a simple summary letter that indicates your goals and the purpose of your loan. This will help show the lender your intent and your reasoning for opting for a hard money loan versus a traditional one.
Loan Application Tips
When you complete the application, make sure you include all pertinent information, and do it accurately. Even one small mistake can delay your approval.
The loan summary should indicate the property address, a description of the property, the LTV you desire, and the total contract price. Anything that’s missing could delay or even derail the entire application process.
Although it might seem like you’re drowning in paperwork, everything your lender requests has a purpose. Make sure you provide the information they need as quickly as possible to help move things along. If you’re using a broker, they will need this information to make their loan presentation and get you approved.
When everything is neat and in order, it’s much easier for the package to be reviewed in a timely fashion. On the other hand, avoid supplying too much information. A good rule of thumb is to only give the lender exactly what they ask for and nothing more or less.
2. Not Choosing a Reputable Lender
Another huge financial mistake you can make is to choose the first lender that comes along without proper verification. You need to make sure your lender is reliable, trustworthy, and that they have your best interests in mind.
Find out a few basic pieces of information before you decide on a lender such as how many years they’ve been in business and if they have lending experience in your particular niche. Ask in advance what information they’ll need to fully process your application.
You should also ask the lender how long their approval process takes, especially if you’re pressed for time. Find out if the lender offers flexible payment plans and if there are any pre-payment penalties.
Don’t hesitate to ask the “hard” questions of your lender. Remember, this is a major financial transaction so you want to make sure you go with a company you can depend on to make things happen.
A good lender and loan officer will respond to your questions in a timely manner and keep you update on the application progress. Make sure they provide you with their contact information including an office phone number, email address, and cell phone number.
Reliable lenders are available to their customers as often as possible. If you find a lender who isn’t responsive, you may want to keep shopping around.
Check the lender’s website to see if they provide good information upfront for their customers. This is a business partnership, so you need the lender to be just as committed to the loan as you are.
3. You Don’t Plan Your Budget in Advance
A hard money loan is a private loan backed by the bank itself. Your monthly payment is typically interest-only until the construction is complete. Once you’re done drawing on the loan, you’ll have to pay the full remaining balance.
Remember that the more money you borrow, the higher your payments will be. You can prevent this mistake by creating a detailed budget in advance so you don’t end up asking for too much money upfront.
If you struggle to make the payments, the property can be seized and you’ll never fully realize your dream. Banks use the property and construction site as collateral which means they can take it if you default.
Create a set budget, but allow for overages in case the project runs into any snags. By avoiding borrowing too much, you can manage the payments much more easily.
Be prepared for a few unexpected expenses and surprises during the construction phase. As long as you’ve included a bit of “cushion” in your budget, you should be able to have the money you need to get the job done.
4. You Don’t Have Enough for a Down Payment
While a traditional mortgage typically requires anywhere from 5 to 20 percent down, a hard money loan may require even more. If you don’t have the required amount for your down payment already in your bank account, your loan could be denied.
Ask the lender in advance what type of down payment they require. Some lenders will go as low as 10 percent, while others may reach as high as 30 percent or even more!
Remember that most banks need you to have some “skin in the game” when you apply for this type of loan. Hard money loans are high risk, so the bank needs some form of reassurance that you won’t default or back out later.
The higher your down payment, the easier it should be to get approved. Some lenders also offer better terms and rates for borrowers who have a higher down payment.
Get the required down payment amount in writing before you start the application process. If it turns out you’re short on cash, the loan could be denied at the last minute.
Always make sure you have some extra cash reserves in addition to your initial down payment. This money can be used to pay for extra construction costs out of pocket so you don’t have to ask for more borrowed money.
Never assume that a lender will be fine with a small down payment, especially when it comes to hard money loans. Get the dollar figure amount on your contract so that everyone is clear about the requirements.
5. You’re Not Sure About Interest Rates
A hard money loan typically has a much higher rate than a standard mortgage agreement. These rates can vary anywhere from 10 percent or higher to the prime rate plus a couple of extra percentage points.
Rates for these loans are higher because the lender is agreeing to take on quite a bit of risk. The higher rate is your way of repaying them for taking that risk on.
So, what’s in it for you? A hard money loan allows you to gain fast access to the cash you need to get your project started. Traditional loans can take a lot longer and are usually wrought with strict requirements.
Remember that your payments will be interest-only at first, so they should be lower than you might expect. Once the project is complete or you’re able to prove financial stability, the loan can convert to something more permanent.
With a permanent loan, you can expect to get a much lower interest rate. Make sure you understand the lender’s rates for hard money loans and how much that should cost you. If you don’t understand this, it could end up costing you in cash paid out and in frustration.
Remember not to become discouraged or intimidated by the higher interest rate. You can always refinance later into a permanent loan with a much lower rate for lower monthly payments.
Avoiding a Financial Mistake
It’s easy to make a potentially serious financial mistake if you don’t know what to look for in your next hard money loan. Do your research and find a lender who will provide you with the help you need to navigate the process.
Be aware of your budget far in advance and make sure you ask for enough money, but not too much. Provide the lender with the information they need to make a decision that will help you get quick financing.
Whether you’re planning to fix and flip, do some new construction, or you need a bridge loan, visit our website and contact us today and we’ll be happy to answer all of your borrowing questions.