As the owner of a hard money lending business, I’ve seen so many new investors think they can go at it independently. It seems easy enough: give money to other investors, then sit back and collect the interest and profits. But, unfortunately, as with all things in real estate, there’s much more nuance to it. So, do you want to know how to become a hard money lender?
There are two ways to become a hard money lender. First, you can finance the business yourself through your savings, retirement accounts, or lines of credit. The other way is to create an LLC or fund which brings on outside investors who receive a certain interest rate every year on their investment. In this scenario, you’ll usually collect a percentage of the profits plus a yearly servicing fee.
Let’s dig into what exactly a hard money lender is and what sort of business model they have. I’ll also dive into the differences between funding the business yourself, funding the business with investors, and the important terms you’ll need to know before creating a partnership.
What is a Hard Money Lender?
The method behind becoming a real estate investor is pretty straightforward: finding a property, paying for the property, and selling the property.
“Pay for the Property” is where hard money lenders come into play. A hard money lender helps potential investors bridge the gap between the money they have available and the amount of money a bank will offer as a mortgage.
A few stipulations come along with using hard money lending services to finance real estate deals. While they’re happy to help a growing business like yours, these lenders aren’t interested in being long-term partners on a single property with you.
Hard money financing usually comes with a higher interest rate than a mortgage would. However, their payment terms are also much shorter; you’d be hard-pressed to find one that will give terms longer than a few years.
Why Would Someone Need a Hard Money Loan?
Short-term financing with high-interest rates and quick repayments. Why would a real estate investor use such a service? The short answer is that savvy investors know the cost for hard money now will yield awesome profits later.
Why Only Short-Term Loans?
The reason for this is that hard money lenders see themselves as a stopgap and a temporary solution. Their goal is to recoup their loan as quickly as possible through your mortgage. Since they have short-term money goals with investors, they’re less stringent on credit scores and debt-to-income ratios.
There are two ways to become a hard money lender: Finance properties yourself or bring on investors.
How to Become a Hard Money Lender on Your Own
If you’re interested in becoming a hard money lender by yourself, then you’ll need to tap into your own resources for financing.
Investors who go this route usually pull money from 401ks, IRAs, personal savings accounts, or will utilize a line of credit.
Using credit cards is also an option, though you might find a line of credit to be more suitable for real estate investing. Lines of credit usually offer higher amounts you can borrow and are easier to access as cash.
How to Become a Hard Money Lender with Investors
A more popular route than going at it by yourself is to bring on other partners. It’s crucial that you understand while you may have access to more cash, there are many more legal requirements you’ll need to adhere to. To get started, you should create an LLC or fund dedicated solely to your lending business.
Most often, investors will come on as a deal-by-deal basis rather than ongoing. Consider this business style more like a broker than a partner. You, as the broker, will collect origination fees and recoup costs while your investors will collect the interest accrued.
Since there are multiple interests to protect, there are usually detailed contracts involved. There might also be licensing requirements in your area for transactions dealing with homeowners and real estate investments. It’s best to consult an attorney before undertaking any sort of partnership, as the requirements will vary by state.
While your investors will collect the interest payments after paying you for your costs and fees, there are other aspects that will need to be hammered out. As an example, consider servicing fees (things like collecting payments, etc.). Who will be in charge of servicing your loans, and how will they be compensated for their work?
There are a few other things you’ll need to know before bringing on outside money for your business. But, first, let’s discuss preferred returns and accredited investors as you’ll run across these the most in your hard money business.
Preferred return investors are investors who put a certain amount of money into the business. In exchange, they’re guaranteed a certain percentage (usually around 8%) on their investment. Once a loan is paid back to your business in full, there will also be a split in profits. The split varies, but I’ve seen it go around 70/30, with the 30 going to you.
However, there will also be a management fee paid to you each year of around 2%, so you’ll still be able to pay yourself without needing to wait for your loans to come in before earning an income.
This is a legalese title for investors who meet certain criteria. They’ll have a net worth of $1 million or have a combined yearly income of $300,000 over a certain amount of years. Check your state laws to see what the time frame is, as it changes often. There may also be some updates to the criteria, but it’s a good thing in the government’s eyes if your investor can meet this standard. Having an Accredited Investor status tells the government that your investor would be okay if they lost money on a real estate transaction, which will make your business have fewer loopholes it needs to jump through.
Becoming a hard money lender can be as simple or complex as you want. If you’re able to finance the business yourself, it may free you from several legal requirements you’ll need to meet. On the other hand, bringing on outside money will allow you to service more real estate investors and grow your business quickly. It’s up to you which way will work best for your situation.
Do you have any tips for becoming a hard money lender? Leave a comment and let us know.