In the busy society we live in today, managing financial assets and loans is ever more important. The inability to keep track of debt can lead to outstanding balances and additional fees. No one wants that, especially when you’re flipping property. In particular, calculating hard money loans is vital to a flipper’s financial wellbeing. In this article, we will discuss what a hard money loan is and how you can calculate it.
What Are Hard Money Loans?
Private Money Loans
A hard money loan—also called a ‘private money loan’—is a type of debt used in settling real estate transactions. These loans are based on the value of a property rather than a buyer’s qualifications. Hard money loans are often more expensive than traditional financing methods, but lenders will tell you that these loans are the quickest route to property flips.
How Do These Loans Work?
The short answer is when you set a contract with hard money lenders, they supply short-term payments used to flip a property. This is essentially a start-up cost for a project.
However, there are upfront costs, ongoing interest, and total costs for using the loan over the borrowing period. For this reason, private money loans can be quite expensive. In the following sections, we’ll discuss more how these all work.
The Details of Hard Money Loans
The Borrowing Duration
Private money loans usually last about a year, but the term can extend to up to several years. These loans incur a monthly payment of interest with a larger sum after the borrowing term.
How Much Can You Borrow?
The quantity of the money borrowed depends on the value of the property associated with the transaction. If the borrower already owns the property, he or she can offer it as collateral. Lenders are more concerned with the property’s value than the borrower’s credit standing. If the borrower cannot payout, the private debtor may seize the property instead.
Who Can Apply for Hard Money Loans?
Borrowers unable to get traditional financing from a bank can still apply for a private money loan. As we mentioned, the borrower can use the property as collateral to increase their standing with the lender.
How Do You Calculate a Hard Money Loan?
There are many details involved in calculating a hard money loan. These terms include: purchase price, after-repaired value, repair costs, the lender’s expected loan to value ratio, interest rate, the repayment term, and upfront points and fees.
This is the lump sum you have to pay by the end of the borrowing term. Knowing your purchase price is crucial before you commit to a private loan. If you cannot get one, at least figure out an estimated or projected value.
After Repaired Value
This is the resale value of the property after you flip and sell it—hopefully for a profit. It can offset the purchase price and other fees associated with the money contract.
Flipping estates involves repairing and renewing the property’s assets, usually by buying tools and resources. This will subtract from any net profits.
Expected Loan to Value Ratio
Lenders will loan a large portion of whatever startup money you need to flip a property. This is typically a percentage of the purchase price, also known as the ‘after repaired value (ARV).’ A lender might offer 80% of the purchase price, and others may offer 60%. It all depends on how risky they think the business venture is and how much the property is worth.
Interest is an additional cost of borrowing from lenders. Hard money lenders usually charge higher rates (up to 12% to 18%) over a shorter term. This differs from mortgage rates, which are at a lower rate and for a longer term (~4%).
Keep in mind that hard money loans are short-term, usually a year or two. This can influence the total interest you pay as well as how long you have access to the borrowed sum to finish your flipping project. Talk with your lender and establish a term that is reasonable for both of you.
Upfront Points and Fees
Lenders can charge points, which serve as a form of prepaid interest. Each point equates to 1% of the total loan.
Property flipping isn’t cheap, but private money loans provide a short-term and convenient way to finance a project. Have all the variables secured and written down with your lender before you sign the contract. Factor the financial liability into your budget and determine what rates, repayment terms, interest, and other variables are appropriate for your flipping project.
We hope this article has given you a sound understanding of how hard money loans work and how to calculate them.