Hard money loans are a form of short-term financing available by borrowers who either suffer from a poor credit score or do not qualify the high lending requirements set by traditional lending institutions.
One of the most important reasons why borrowers turn their heads towards hard money lenders is to avoid a high credit score requirement. Does this mean that hard money lenders do not look for any sort of credit? The simple answer is it depends.
While hard money lenders do not actively try to find only those borrowers who have a great credit score – they still have a different set of criteria they follow which helps them decide whether they want to provide funding.
As a borrower, you should understand that some specific situations make it more suitable for you to avail of hard money loans. Even when you have a good credit score, it sometimes makes more sense to avail of hard money loans than traditional financing.
Situations that make hard money loans the best form of financing
Availing a hard money loan is an ideal type of financing in the following four cases:
When the borrower is looking to repair an existing property and then flip it for profit – these types of transactions are generally called the fix and flip property transactions, making it one of the ideal scenarios for a borrower to avail hard money loan.
When the borrower wants to act quickly for a real estate investment deal and needs immediate financing, there might be many times when an investor is needed to strike the iron in real estate. At the same time, it is hot, and decide to invest in a property.
In such cases, hard money loans are the best type of financing as they can be processed within days or a few weeks.
When a borrower wants to get a construction loan for land which will sell after constructing a building on it, when the borrower is certain about the return on investment of the loan – he or she can proceed with the hard money loan.
Lastly, when the borrower wants to prevent a credit risk, it is ideal for him to approach a hard money lender.
The dreaded credit check by the hard money lenders
Like any other traditional lending institution, a hard money lender will also conduct due diligence when they first apply from a prospective borrower. As opposed to the common public opinion that hard money lenders are very lenient when it comes to lending, the reality is that hard money lenders are also looking for some kind of credit in the prospective borrower.
In essence, hard money lenders also perform a credit check. The method in which they conduct a credit check varies significantly from the method used by banks and other traditional lending institutions, but that does not mean there is no check on credit.
To understand your financial position – your lender will need to know if you have a low credit score, and they might also check up on your outstanding IRS tax liens or if you have any foreclosures in the past. This is the industry norm, and this is how private lenders would first want to check your credibility.
However, as opposed to banks that decide to lend you money or not solely on these norms, private lenders look at many other factors. In other words, while banks shun their doors on you, Private money lenders will open their doors and work out a way to land you the requisite amount.
In most cases, they will look for alternative options that will be feasible for both parties. For instance, they might suggest you partner with some other borrower who has a high credit score in exchange for some fees or higher interest.
Thus, hard money lenders use unique ways to test your credibility, and the high degree of customizability you will experience with hard money lenders is like no other. Moving beyond the credit score, hard money lenders are also extremely interested in the property value you intend to purchase.
Suppose you can convince your hard money lender about your cash flows and can show them your loan repayment capacity, demonstrating how you will clear off your interest dues along with the principal payment. In that case, chances are a private money lender will fund your loan.
Even in a case where you have a very poor credit score – you can still draw a projected financial statement for the next one or two years and prove to your lender about your loan repayment capacity.
On the other hand, if you cannot prove to your lender how you intend to pay back your loan, getting hard money loans can also be difficult. Remember that private money lenders are also looking to minimize their potential risks.
Hard money lenders don’t necessarily consider the trifecta as a deal-breaker
One of the most off-putting things about banks and traditional lending institutions is their policy of Trifacta – where they refused to provide funding to borrowers who you have one of the big three factors which deface one’s credit score: (1) Bankruptcy (2) IRS Tax Liens (3) Foreclosures.
In essence – if you are a borrower and you have a bankruptcy or previous foreclosure or IRS tax liens, then your chances of getting a loan approved by a bank or other traditional learning institutions are close to zero. However, the good news is that hard money lenders do not necessarily consider these three things as major deal-breakers.
Private money lenders are interested in understanding the circumstances that led to the financial distress and willing to fund your loan if you can assure them that this won’t happen again and show them a projected income statement for coming years. Working with reputable hard money lenders will always put you in a good position, especially when you start as a real estate investor.
Hard money lenders will not let your credit score exclude you from commercial real estate investing, unlike banks that downright refuse to lend financing to borrowers with a bad credit score. As a matter of reality, most hard money lenders work with borrowers who have a low credit score.
Thus, in a nutshell, if you can convince your private lender about your loan repayment capacity and assure them of your income flows in the next few months and years – the chances are that you will find a hard money lender in the market who will fund your loan.
Thus you can rest assured that a poor credit score will not stand in your way of investing in commercial real estate.