Hard Money Lending Questions

It might be easy to take for granted that certain things go hand in hand without probing deeper, such as peanut butter and jelly…or real estate investing and hard money loans. Even things that might seem obvious can be demystified if we ask the right questions. When you apply for a hard money loan, it is not just your potential lender that will be asking the questions: do you know what questions you should be asking them during this process?

No question is too obvious or too small to ask a potential hard money lender. Every hard money lending company is different.

To jump-start your list of questions for vetting a hard money lender, many questions can be grouped into broad categories such as questions for laying the groundwork, questions for establishing the loan, and questions for moving forward.

Questions for laying groundwork with a Hard Money Lender

When starting to search for a hard money lender, you will probably first be wondering: how do you find this sort of lender in the first place?

Your best bet is to go for a local hard money lender. There are large hard money lenders that operate nationally, but you can get a more nuanced experience with your local real estate market using a local lender. They are more likely to have great rates because they will understand your local market and its risks. Smaller and more local hard money lenders also tend to give more careful attention to appraisal and risk assessment, resulting in less chance of default than with a national company who might have less awareness of the trends in your area. Probing potential lenders about your local real estate market can help you determine potential good fits.

After identifying a local hard money lender, you can ask them their perspective on the area real estate market – hearing their sense of the area’s financial landscape will be a revealing indicator of a savvy hard money lender. A hard money lender in the local area will also likely have more experience with area contractors, which can lead to a smoother overall rehab experience. It is important to fully vet and trust your hard money lender, especially if you hope to seek referrals for contractors for your rehab. That’s why asking questions about reputation and track record are important too!

Once you’ve found a potential lender—whether through online research, advertising, or word of mouth—“ask” the community’s opinion by searching for feedback and reviews from that company’s clients. A quick Google search makes it easy to get a sense of a lender’s reputability. Reviews and testimonials from past borrowers will likely come up. In addition to reviews online, you can ask the company itself if they’d be willing to share references or recommendations, or even if they would be willing to put you in contact with past borrowers.

Once you have found a lender to work with, set up an initial meeting or consultation with them to gain more information about how they establish their loans. You will want to make sure your goals and financial situation align with their requirements.

Questions for establishing the loan

A hard money loan is a cash loan that is determined on specific property value: the after-repair value. However, different hard money lenders may determine this value differently. As this number critically impacts your loan value, be sure to inquire about it! Ask your hard money lender how they derive their loan to value ratio and what guidelines they follow to do so.

The loan to value ratio is determined by assessing the potential value of the property, then determining how much of that value the company can offer you. You can ask how the lender will value the property. Most will draw upon comps from the MLS database and determine based on the median value. Comps are just what they sound like: comparisons. The Multiple Listing Service database is a real estate resource where records from licensed realtors are available to compare your property against, using factors such as property size, location, and features. Be sure to ask your hard money lender to pull these numbers for your local area market in order to get a more accurate sense of what your ARV—and therefore the loan value—will be.

Once you have a handle on comps for your property and how your hard money lender assesses that value, you would then want to ask what the hard money lender’s standard after retail value percentage is. A standard ballpark is 70%, meaning you would receive 70% of the projected after-rehab value of the property. This percentage could affect your flexibility in selecting a property to work with, so be sure you ask about it early on after establishing a relationship with a hard money lender. Most hard money lenders will want to see you buying a property under market value so that your profit margin is likely to be larger. It is more likely that a small or local hard money lender will offer funds at higher than 70% of the ARV. This would be more advantageous for your loan.

If you are new to real estate investing, the disbursement process is one that you should focus your questions on. This is an area that seems especially prone to generalized assumptions. Remember that loan money earmarked for a property purchase will be dispersed first, with construction disbursement to follow at intervals. Ask if your lender disperses by construction benchmarks or at regular intervals of time. You may also want to ask your hard money lender who is dispersing the loan.

Many times, the hard money lender finances the loan, which is dispersed at pre-determined intervals by a related title company, with a third party overseeing and ensuring that both parties are responsibly and reliably handling your money. Every title company is a little different, so you will want to ask what their role is in your disbursement. Sometimes title companies do handle construction cost disbursement depending on the circumstance. Due to the slight variances in practices across different local real estate investing markets, do your best to never make assumptions about the hard money lending process and ask questions every step of the way.

Ask about lender expectations

Up till this point, we have focused on questions you should prepare to ask your hard money lender. However, at this stage in your interview with your lender, it would be wise to also ask any clarifying questions you may have about what the lender would expect of you, the borrower, such as:

Do I need to have a minimum account balance or reserves?

What are your borrower requirements for net worth and / or liquidity?

Many companies have requirements based on the borrower’s experience with real estate investing or rehabbing. In general, lenders prefer to see that people know what they are doing; this mitigates some of the risks associated with lending on real estate projects. This is another area where working with a local lender would be more advantageous than a national hard money lender: many large lending companies will increase the loan’s interest rate or offer a lower ARV and loan percentage if you have never flipped a property or previously been a landlord.

There are then logistical questions pertaining to how the loan will function to consider. Two short and straightforward lists of questions to discuss with your lender are:

  • What are the terms of the loan? As hard money loans are short term in nature, you will want to receive a clear answer from your lender on their standard loan lengths. It could be as short as a few months, to up to two years.
  • What is the interest rate on the loan? You can expect a hard money loan to have a higher interest rate than a loan from a bank, as the ARV valuation model is considered by some to carry the unique risk of attaining the ARV in your allotted amount of time. However, since hard money loans are sought for inherently short-term real estate investment situations such as flips, this is not so much a question to prompt worry rather than orient your expectations and budget to the reality of your project.

With these sorts of questions under your belt and the parameters of the loan established, it is time to ask some questions about moving forward.

Questions for Moving Forward

Following the previous line of questioning, there is another important financial aspect of hard money loans to discuss with your potential lender: points on the loan. Points are an origination fee that usually pertains to the legal footwork of preparing the loan, and can cover preparatory work such as drawing up the contract, and covering other lender costs of doing business. Ask your lender if they charge points, and if so, at what percentage of the loan value. It would be fair for you to expect one point to correlate to one percent of the entire loan amount. However, this could vary slightly, so be sure to ask directly what your lender’s point value is.

Relatedly, there can be hidden costs associated with being awarded your loan that result from standard third-party reports, such as environmental reports and structure reports. Ask your hard money lender what, if any, third party reporting they require for working with a borrower on a property. Be sure to ask what the cost of this process is if required, and if it is factored in with the points or separately. It would also be good to clarify in general if points are calculated as part of the loan to value ratio when that number is established, or if it is determined separately and based on what factors. You are more likely to encounter hidden fees beyond the points charged if you are working with a national hard money lender. Make sure to ask for their entire fee schedule.

Other things to think about

As you converse with your hard money lender and learn about their procedures, other miscellaneous questions will likely arise. To help you cover those bases as well, a few other general questions to ask could be:

  • How do you appraise the property? At FasterFunds Lending we provide that service internally and do a walk-through of the property. That way we don’t need to charge the customer for an appraisal. Other companies will vary, so it can’t hurt to ask. Many companies require a full appraisal that will cost the client $400 to $600 per house.
  • How long does it take to close on the loan? With a hard money lender you can assume this will be a fairly quick turnaround, 3 – 10 business days, so long as the preliminary reports go smoothly, proof of insurance is easy to demonstrate and there aren’t any titling issues. Be sure to first ask what your lender and title company anticipate the closing time to be, and factor that into the rough schedule of your real estate project.
  • Are there any prepayment penalties if I decide to sell or refinance before the loan matures? Prepayment penalty means that if you pay off the loan before it matures, or reaches its due date, there is a fee. This is not as common with smaller or local area lenders. It is good to ask about this so you can add that number into your financial safety net. Borrowers sometimes pay off the loan early due to a change in their exit strategy. Say that you had planned a full demo and flip on a property, but drastic local area market changes force you to re-examine your exit strategy. In this hypothetical you might decide to do a clean and lift project instead, where rather than competing rehabbing the property over a period of months, you do a deep clean and surface touch ups to sell within a few weeks. You’d be selling fast due to market conditions with the prepayment fee cutting into your profits. Asking about prepayment penalties helps you cover all your bases for strategic planning.
  • What’s your rate of foreclosure? The collateral for a hard money loan is the property itself. If the borrower defaults on the loan, the property could be foreclosed. This is clearly a worst-case scenario. While construction, rehabbing, or market catastrophes always lurk as potential threats to the success of any real estate investment, it could be a red flag to see a high volume of houses taken back by one lender. That suggests that they are not assessing the financial safety and risks for their borrowers, and could be recklessly offering loans that aren’t right for the borrower’s projects. A low take-back rate indicates that a lender is more likely to work with their borrowers when things get challenging and are interested in building reliable, long term relationships. Ask why they take back houses as well. By asking this question you can discern if your lender has your interests in mind and values win-win situations.
  • On the topic of win-win situations, it would also be good to ask: what resources does the potential company have for you the borrower? A great example resource is a cash flow analyzer, financial calculator, which helps you assess good deals on rentals. If you are borrowing hard money to rehab a property for a rental, you will want to anticipate the cash flow on that property before purchasing the property, taking out the loan, and embarking on the construction journey – if the property can’t cash flow like you want it to, you may need to seriously rethink your investment strategy for the property! As simple as it sounds, cash flow is the money you can expect to receive from tenants, with the cost of regular property maintenance and expenses factored out. Ideally, this number will be profitable. Ask your hard money lender if they have tools or calculators for analyzing potential cash flow, and identifying where the property will be profitable and where costs could arise. For real estate investors in the greater St. Louis area, FasterFunds Lending offers a cash flow analyzer on our website that can be found (here).

Asking the right questions in advance of receiving your hard money loan can set you up for success. Always ask questions when you feel you need to, especially when vetting a lender—that relationship will be important for your overall investing. Inquire about the steps involved in getting the loan prepared, closed, and disbursed so that there are no surprises to throw you for a loop during your rehab. No question is too small. Cover your bases by preparing with a list of questions for your local area hard money lender – it will be a big step to entering a win-win real estate investment situation.