Hard money lending is probably by favorite way to make passive income, if you do it right. Hard money lenders are also called private money lenders. As a real estate agent, I first heard about hard money through real estate investing classes about rehabbing properties. Since rehabber usually can’t get loans to flip properties, they find private lenders to fund the costs of acquisition and repairs.
What is hard money (or private money) lending?
Hard money lending is basically private financing for a real estate asset. First, it is difficult for rehabbers to get a regular loan because flipping properties in a short time frame is a risky investment. Institutional lenders (e.g., your bank) does not want this type of risk, so they won’t loan on these types of properties. Second, experienced rehabbers may already have several properties in their name. Typically, if you own more than 4 properties, the lender also views YOU as a risky investment since you may be over-leveraged with too many loans.
So in order to get financing to flip a property, rehabbers turn to private money. Often times, hard money lenders are actually former rehabbers who made a lot of money, and aren’t doing the hard work of actually flipping properties anymore, but just providing the financing behind it. It’s a great deal for them because they know the business and whether or not a deal is risky or not, and they can make a great return without all of the work.
What are the benefits of hard money?
The main benefit of hard money is the passive income and interest rate. In my area, hard money is typically 1-3 points and around a 10-13% interest rate. So for example, if a rehabber comes to ask you for a $100,000 loan, a hard money lender would charge them 1-3 points = $1000-3000 up front when they buy the property and then continually get a check for 10-13% annual interest every month until the property is sold or refinanced.
Another benefit is that you are still owed the interest until the property sells. While out investments are typically for a 6 month period, I once had a rehabber that couldn’t get the property sold for another 4 months, so I got 4 extra months of interest!
You also aren’t subject to the stock market or what is happening around the world. Even if the market tanked today, we would still be getting the 10-13% interest. I like it because it truly is a set it and forget it type of investment. The checks come in like clockwork every month.
What is the risk of being a hard money lender?
The biggest risk is that the rehabber makes a mistake in their numbers and the property doesn’t sell and the rehabber can’t pay you back. For example, let’s say the rehabber buys a house at $150,000 anticipating about $30,000 in repairs and then selling it for $250,000. You fund the $150,000 for the acquisition of the property. The only way you get all of the money back is if he sells the property for $250,000. But there are things that can go wrong:
- Due to unforeseen repairs, the cost of repairs could go from $30,000 to $60,000.
- He made a mistake in the after repair value and the property is only work $200,000.
Suddenly, there isn’t enough money to pay you back. Then, you are in the same position as the banks during the housing crisis. You either have to foreclose on the property or agree to a short sale.
This is why it is VERY important to look at all of the numbers. Often times, “great deals” really aren’t that great. It takes an experienced person in real estate to understand when to say no, and they are probably saying no more often than yes!
Our Experience with Hard Money Lending
Even though I’m a real estate agent, I wanted to be as hands off as I could with hard money lending. I didn’t want to be the one vetting the deals or looking up the after repair value. So instead, I partnered with a seasoned hard money lender. They basically vet all of the deals and use my money for the transaction. They get the upfront points (the 1-3 points at closing) and I get the 13% return.
My husband and I both interviewed the lender to make sure we were both comfortable with them. Once we vetted them, we also started off with a smaller amount to lend (around $20,000) first to see how they worked. Once we got more comfortable we increasing the funds that we were putting in.
To date, we’ve worked with 3 hard money lenders, but we have most our money with one lender that we’ve worked with for about 3 years now. He pays on-time, every month. What I really like about him though, is that he won’t put our money into a deal if he doesn’t feel the margins are good. We’ve actually had him turn down our money!