Hard money lending represents one of the more risky options for investors looking to make their money work for them. Still, groups of investors across the country have established hard money lending firms that make astoundingly large amounts of cash available to real estate investors, businesses, etc. The question is this: how do they make money in such a risky business?
Money is made using the same strategies conventional bankers rely on. Hard money lenders charge interest. They assess points. They charge fees to cover the costs of doing business. It all adds up to a profitable venture – as long as risk is properly managed.
Higher Interest Rates
The bulk of a hard money lender’s profit is derived from interest. As Actium Partners out of Salt Lake City, UT explains, interest rates on hard money loans tend to be quite a bit higher compared to conventional loans. This is a direct result of two things: shorter terms and the inherent risks that come with hard money.
Hard money loans are short-term loans by design. Though some hard money loans can have terms of up to three years, most are two years or less. This gives lenders limited time to earn interest. They make up for it by charging higher rates.
As far as risk is concerned, hard money lending is asset-based lending. That makes it inherently risky. Lenders reduce their risk through higher interest rates. They also tend to be very firm on their LTV’s.
Loan points in the hard money industry are identical to those in the retail banking sector. Lenders charge points equal to 1% of a loan’s total value. Points are offered as a way of trimming down interest rates. For example, a lender might offer to reduce the interest rate by half a point in exchange for a 1-point fee.
Paying higher points is a way to save money in the long term by reducing the amount of time the borrower is paying interest. But it doesn’t always work out that way. In some instances, higher points do not shave enough interest off to make a difference.
Last but not least, hard money lenders charge a variety of fees to cover the costs of doing business. Those fees have a certain amount of profit built in. Examples include appraisal and underwriting fees. Then there are origination fees, document prep fees, and so forth.
Mounting fees are enough to frustrate any borrower. But it is part of the financing game. Lenders are providing a service. That service needs to be paid for. Far better to pay a list of fees upfront than have them rolled into the financing package where they are subject to interest.
Hard Money Lenders Move Quickly
In closing, it is important to point out that hard money lenders do not like long-term commitments. They want to get in and out of a transaction as quickly as possible. Therefore, they move quickly in everything they do.
Short terms allow lenders to get their money out of the transaction more quickly. It allows them to earn their profit in a comparatively short amount of time, then move on to the next project. This desire to move quickly is just one of several characteristics that separate hard money lending from conventional lending.
Just remember that hard money lenders are in it to make money. They do so by charging interest, points, and fees. The amount they charge might seem excessive to some, but that’s only because the risk associated with hard money lending is relatively high.