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in eCreditDaily we analyze conventional loans and non-conventional loans.

Non-Conventional Loans

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Other Loans

We have articles discussing other loans, some traditional, and some subprime loans: stated income loans in general, and their particular situation in California. We also discuss if they are still legal or not.

Getting a mortgage loan only with an ITIN, no doc hard money loans, hard money construction loans, luxury home financing, no ratio loans, and what happened with Funding For Flipping.

FundingForFlipping

Fundingforflipping.com

Funding For Flipping, doing business as fundingforflipping, was a credit company offering funding for real estate investors at the website fundingforflipping.com (1). They are closed since 2021.

When you applied for funding, they requested the prospective borrower information about the credit score. They required a credit score of 700 to qualify, in most cases.

The loan requirements requested by fundingforflipping.com were similar to other lenders regarding the issue of loans for real estate investments.

Fundingforflipping.com was located in 509 W. Old Northwest Highway, Suite 210, Barrington, IL 60010.

It is important that a good credit score and substantial net worth are established before applying for such loans.

It was also necessary to have enough cash on hand in order to cover all upfront costs, which can often include home inspections, closing fees, down payments and so forth. The borrower’s income must be verified according to current lending standards, with documentation being submitted accordingly.

Some prospective borrowers may also be required to provide a co-signer, who will have the same qualifications.

Funding for flipping is often needed when you are not able to get funding from traditional sources because of credit issues or lack of equity in your home.

The advantage of this company was that they are willing to work with a borrower who does not have 20% equity in their home.

Funding for real estate flipping in fundingforflipping.com was the act of borrowing funds and using them to purchase property, which will be resold quickly at an increased price so that the investor can profit from reselling it.

The loan requirements needed before applying for such loans included the same requirements that we understand are typical in the real estate business environment: having a good credit score, substantial net worth, enough cash on hand to cover all upfront costs (such as inspections), and documentation showing income verification up-to-date according to lending standards.

A potential borrower may also need a co-signer who has similar qualifications. Funding for real estate flipping is often required when you are unable to have it funded by yourself or do not want to utilize your own assets.

Fundingforflipping.com
THE COMPANY IS NOT OPERATING SINCE 2021

Fundingforflipping.com Reviews

Fundingforflipping.com reviews were generally positive in the specialized real estate forums. Fundingforflipping.com did not have negative reviews in Better Business Bureau or complaints of any kind, and no file recorded in the FTC.

No Ratio Loans

During the mid-2000s, mortgage lenders displayed an overzealous enthusiasm for granting mortgages just with a stated income declaration, and also no ratio loans (1) (2). The self-reported income information was not verified, so any exaggeration of income could result in an application being approved by banks and non-bank lenders (6). If borrowers desire to qualify, they must provide self-reported and unverified information, and this information may be exaggerated or incorrect (7). In the wake of such reckless lending behavior, many buyers have been saddled with large mortgages that they were unable to qualify for (8). Therefore, the risks associated with the housing market in 2008 arose (3), contributing to a variety of economic difficulties (5) that also impacted no ratio loans, in the form of high unemployment rates (9) and other outcomes (4). As a consequence, it was defined by the Consumer Financial Protection Bureau that loans should consider a debt-to-income ratio of the borrower of at least 43% (10).

A no ratio loan is a type of loan, utilized for mortgage loans, for which there is no consideration of the standard 43% debt-to-income ratio of the prospective borrower by the lender during the underwriting process thereof. No ratio loans hedge the additional risk of ignoring the debt-to-income ratio of the borrower with a downpayment of an average of 36% of the purchasing price of the home plus reserved funds to satisfy a year of mortgage payments.

Even though luxury home financing is not a conventional mortgage loan, it cannot be a no-ratio loan. The reason is that there are consumer protections governing what the Consumer Financial Protection Bureau defines as a “qualified mortgage”: a loan system with different standards and regulations than conventional loans, such as the 43 percent debt-to-income ratio.

Generally, high credit score borrowers with an asset portfolio as well as outstanding credit scores are the only ones who will qualify for these types of loans.

The potential borrower may not be able to collect the necessary documents to be approved for a loan if he or she cannot gather the required documents to be selected for consideration.

Thus, in these cases, a no ratio loan could prove helpful.

Normally, a no ratio loan does not require borrowers to disclose his or her debt-to-income ratio to the lender – thus, the borrowers are able to obtain a loan without having to disclose anything, provided that other requirements are fulfilled accordingly.

The debt-to-income ratio of a person indicates the percentage of his or her earning that is set aside for debt repayment each month.

There are loans that are offered without income verification, so the lender does not have to take into account the debt-to-income ratio when they make the loan.

These types of loans are recommended for people who don’t want to reveal their income. With a No Ratio loan, a borrower’s credit score is excellent and they have a substantial amount of assets, which more than compensates the lender for the fact that the income information and the debt-to-income ratio were not taken into account.

The ratio of debt-to-income, which represents how much debt the borrower has relative to the amount of income the borrower makes, is often a major factor lenders consider when determining whether to grant financing for traditional mortgage applications.

It is possible for a loan application to be rejected if the debt-to-income ratio of the applicant exceeds the acceptable level. This is, however, not the case for the no ratio loans that we are discussing today.

Rather than that, the borrower should be able to demonstrate his or her ability to repay through a good credit rating and a low loan-to-value.

It is not necessary to provide a statement of income with these types of loans, although they tend to be requested. The debt-to-income ratio is not revealed.
For example, self-employed individuals or those operating on a commission basis often have difficulty proving their earnings, so these loans are ideal for them.

For example, mortgage lenders have strict requirements for mortgage applicants, where a debt-to-income ratio of 36% or less is generally required.

A no-ratio mortgage – a mortgage in which the lender disregards your debt-to-income ratio – is a product that is typically only available to individuals who are self-employed. The rationale is that providing conventional income and asset verification may be more challenging for self-employed people.

It is also important to consider that income from self-employment fluctuates. Moreover, income from such sources is not necessarily shown on a tax return. 

There might be income that is not included in your tax return at all. Most entrepreneurs who own or run a business take many deductions out of their income, which results in a lower taxable income and a lower tax liability.

Lenders would not be able to determine from such information whether the self-employed person is truly earning a certain amount of money.
In short, a no ratio loan, as the name implies, does not consider debts to incomes ratios. It is true that there is full documentation and proof of income, but the borrower is not required to meet any qualifying ratios in order to qualify.

When it comes to securing mortgage funding, some people may find themselves facing difficulties due to their debt-to-income ratios, or the amount of debt a person owes in relation to their income.

There are no-ratio mortgages, which are mortgages where potential borrowers do not have to provide income verification. These types of mortgages are traded at a slightly higher interest rate to compensate the lender for the extra risk it is taking on by not verifying the income of the prospective borrower.

It may be appropriate to use a no-ratio credit line for self-employed borrowers that have substantial tax deductions, borrowers that have substantial savings, or borrowers that can only prove a portion of their income.

When a lender deems you eligible for a no-ratio loan, ensure that the installments you will have to pay for the loan are reasonable. It is true that ratio loans can and do have their place and purpose, however, they should never be used as a method of extending a potential borrower’s eligibility.

Loan Requirements For No Ratio Mortgages

To qualify for a no-ratio loan, normally a no ratio mortgage loan, the prospective borrower is required to perform a down payment of a modal average of 37 percent of the purchasing price of the real estate object plus the disponibility of reserve funds to cover a year of the mortgage installments.

During the credit check process for the lender, your source of income will be validated as well as your self-employment status for the past two years. It means that you are going to have to prove that you are operating a legitimate business.
Moreover, you will have to possess a good credit score as well.
Contrary to traditional underwriting criteria that require borrowers to submit tax returns, paystubs, and W-2’s, lenders of no ratio loans offer their products on the basis of credit scores and their overall financial profile.

In addition to the reduced documentation requirements of a no-ratio mortgage, self-employed borrowers may also benefit from the reduced requirements of such a mortgage if they have undocumented additional income.

Your credit history will determine whether or not you will be approved for a no ratio loan since it is the most crucial KPI (Key Performance Indicator) that must be considered during the underwriting process.

A financial institution views no ratio loans as a riskier proposition, which means you will pay a higher interest rate if you opt for a no ratio loan as a borrower. 

Features Of No Ratio Loans

  • No Debt-To-Income ratio calculated.
  • Houses, condos, and Planned Unit Developments (with approved zoning) included
  • Loan-to-value ratio as high as 75% and if it is a first-time homebuyer, the maximum will be a 70% LTV.
  • Second homes eligible.
  • Normally “owner-occupied”. Corporations’ and LLCs’ eligibility should be discussed case by case.
  • Loan approvals available without asset seasoning
  • Minimum 680 to 700 FICO
  • No tax returns, no W2s, and no income verification
  • Loans up to $2,500,000 or higher in some cases
  • Loans available in all 50 states, but not all financial institutions offer them.
  • No restrictions on cash-out financing
  • Simplified asset verification with only the earnest-money deposit check and one-month bank statement covering at least thirty days.
  • Not a bank statement loan, but requires 5/6, 7/6 ARM (adjustable-rate mortgage), 15 or 30 years fixed.
  • The rate of interest you will be charged on a no ratio loan that is assumably the rate on a typical mortgage will be approximately half a point higher, but depending on the loan-to-value ratio on the property, the lender may increase the rate.
  • Additionally, most lenders require that you work at the same position for a minimum of twenty-four months, otherwise, they will raise the interest rate on your loan.
  • Up to 100% of borrower funds may come from gifts. Gifts allowed for a down payment, closing costs, and reserves.

Benefits Of A No Ratio Mortgage

No-ratio mortgages are a type of no ratio loans and are perfect for borrowers with good credit histories who lack the income documentation required under the underwriting guidelines for a conventional mortgage. Less documentation could mean less processing time for the mortgage and a quicker closing for borrowers in a rush to complete a transaction.

Another way that you can be approved for a no ratio loan is if you are not financing your entire home. If you are borrowing less than the value of your home you will most likely be approved. This type of loan is used to finance smaller projects, not to purchase big-ticket items. 

Finding No Ratio Loans With Mortgage Brokers

You may need to consult a mortgage broker to find a no-ratio mortgage since larger banks and other conventional lenders no longer offer them, and you probably will not be able to get a fixed 30- or 15-year loan.

Typically, these loans come with an adjustable interest rate, and they may be slightly higher than the rate for a conventional loan.

That is because you, as the prospective borrower, have to compensate the lender for the extra risk it assumes by giving you a mortgage without being able to verify your debt-to-income ratio.

Conclusions

Although strict no-documentation loans are rare, no-ratio mortgages, a modified version of the no-doc, and stated income loans are still available on a limited basis for people who meet certain requirements.

With these no ratio loans, you do not need to verify your income for the lender, but they are not easy to find. Mainstream banks steer clear of them, and they are typically available only to self-employed borrowers.

This loan can be a quick and easy process for borrowers that would have difficulty gathering documentation. Keep in mind that very few lenders offer this type of loan at the moment, but those who do would be happy to find a prospective customer like you.

Luxury Home Financing

What is luxury home financing?

There are luxury home financing products available in the United States that are used to entitle borrowers to mortgages on properties without conforming to traditional mortgage guidelines (1) and cannot be delivered or negotiated with institutions like Fannie Mae (5) due to the fact that the loan amount exceeds the legal limits for conforming loans (2). For the vast majority of counties in the United States with some exceptions in non-contiguous states (7), the maximum conforming loan amount is $548,250 after the Federal Housing Finance Agency (FHFA) (3). There are jumbo loans available for those loans that exceed the local conforming loan limit and those are considered non conforming loans (4) (6).

Luxury home financing is a type of mortgage loan that exceeds the loan limits set by the Federal Housing Finance Agency (FHFA). Unlike conventional mortgages, luxury home financing is not eligible to be neither purchased, guaranteed, nor securitized by Fannie Mae or Freddie Mac. Designed to finance luxury properties and homes in highly competitive local real estate markets, luxury home financing come with unique underwriting requirements and tax implications.

In the event that you would like to purchase a home that costs nearly half a million dollars or more and are not in a position to handle the payment through your bank account, you’ll probably need to take out a jumbo loan to secure luxury home financing. There is a strong likelihood that you will have a much more difficult time obtaining one than you will if you apply for a conventional loan or an FHA loan. There is no guarantee from Fannie Mae or Freddie Mac when financing a luxury home. Because of this, lenders are more inclined to take on more risk when financing a luxury home. Aside from the fact that the government isn’t guaranteeing these transactions, there is also the fact that the transactions are involving more money.

The average borrower commonly uses a so-called conforming loan, which is backed and capped by the government. For most of the country, the limit is $424,100, but in pricey Los Angeles County, the maximum is $636,150, according to the Federal Housing Finance Agency.

Luxury home financing, performed through mortgage loans, exceeds the mortgage amount that Fannie Mae and Freddie Mac will purchase from lenders.

It is possible in this model to acquire a property behind the curtain of an LLC, protecting privacy and avoiding having the property in our own name. This is not possible in conforming loans, but here we are discussing a non-conforming mortgage loan.

High-net-worth home buyers are attractive to lenders because their substantial income and assets make them appear to be less of default risk. And many banks offer loans to entice premium clients.

That is why loan requirements are different than conventional loans and typical FHA loan requirements.

Loan Limits In Luxury Home Financing

The loan limit for conforming loans varies by county because some real estate markets are much pricier than others. For 2021, the conforming loan limit for one-unit homes in most counties nationwide is $548,250. However, in “high-cost areas,” especially in the Northeast and on the West Coast, conforming loan limits are expanded to $822,375 — and even higher in a few other places.

Also FHA loan limits are much lower than for these non-conforming loans.

A luxury home financing is a mortgage used to finance properties that are too expensive for a conventional conforming loan. The maximum amount for a conforming loan is $548,250 in most counties, as determined by the Federal Housing Finance Agency (FHFA). Homes that exceed the local conforming loan limit require a specific luxury home financing.

The value of luxury home financing varies by state—and even county. The FHFA sets the conforming loan limit size for different areas on an annual basis, though it changes infrequently. As of 2021, the limit was set at $496,375 for most of the country. That was increased from $453,100 in 2018. For counties that have higher home values, the baseline limit is set at $726,525, or 150% of $484,350.

Also called non-conforming conventional mortgages, luxury home financing is considered riskier for lenders because these loans can’t be guaranteed by Fannie and Freddie, meaning that the lender is not protected from losses if a borrower defaults.

Luxury home financing is typically available with either a fixed interest rate or an adjustable rate, and they come with a variety of terms.

Loan Requirements For Luxury Home Financing

Underwriting criteria for luxury home financing are stricter because the loans are larger and riskier for lenders.

  • High credit score: Higher than 700.
  • A debt-to-income ratio of at least 43%
  • Down payment of about 15%
  • Cash reserves to cover at least one year of payments of the loan.
  • 30 days of pay stubs, W2 tax forms for the last two years and some lenders would require copies of 1099 forms issued.
  • Two months of bank statements.
  • Home inspections and appraisals are required as usual.

Just like traditional mortgages, minimum requirements for luxury home financing, as nonconforming mortgage loans they are, have become increasingly stringent since 2008.

Credit score

Lenders may require your FICO score or credit score to be higher than 700, and sometimes as high as 720, to qualify for luxury home financing.

Many potential borrowers are famous people, including entrepreneurs, film producers, and athletes. Some of them are not focused on their day-to-day financials, resulting in less-than-stellar credit scores.

Debt-to-income ratio

Loans without consideration of the debt-to-income ratio are the no ratio loans, and we discuss in this article, how can you apply for one. Nevertheless, this is not the situation of this type of loan we study here.

Despite the fact that luxury home financing is not a conforming mortgage loan, it must still comply with consumer protection provisions for what the CFPB finds to be a “qualified mortgage”: a lending system with standards and rules unlike traditional-home loans like a 43% debt-to-income ratio.

Lenders will also consider your debt-to-income ratio (DTI) to ensure you do not become over-leveraged, though they may be more flexible if you have plentiful cash reserves. Some lenders have a hard cap of 45% debt-to-income ratio, however.

To become approved, you’ll need not only the superb credit score described above: 700 or above but also a very low debt-to-income (DTI) ratio. The DTI should be preferably under 45% and even better if it is around 36% according to some niche underwriters, but the average we recognize is right below 45%.

Down Payments For Luxury Home Financing

In the first version of this article, I was writing that lenders of mortgage loans for luxury home financing required home buyers to put up to 30% of the purchase price of the residential property (compared to 20% for conventional mortgages).

However, down payment requirements have loosened currently since 2022. Now, that figure has fallen as low as 10% to 15%.

As with any mortgage loan, because that is how luxury home financing is arranged, there can be various advantages to making a higher down payment, among them, to avoid the cost of private mortgage insurance, lenders require down payments below 20%.

Therefore, if you are interested in a lower down payment rate (lower than 20%), you could be required by your lender to become a policyholder for private mortgage insurance, an extra cost to weigh in your options.

Cash reserves

You’ll need to prove you have accessible cash on hand to cover your payments, which are likely to be very high if you opt for a standard 30-year fixed-rate mortgage.

So you are more likely to be approved for luxury home financing if you have ample cash in the bank. It is not uncommon for lenders to ask luxury home financing borrowers to show they have enough cash reserves to cover one year of mortgage payments.

Documentation Required For Luxury Home Financing

Specific income levels and reserves depend on the size of the overall loan, but all borrowers need 30 days of pay stubs and W2 tax forms stretching back two years.

To prove your financial health and become suitable for luxury home financing, you’ll need extensive documentation, perhaps more than for a conforming loan. You should be prepared to hand over your full tax returns, W-2s, and 1099s when applying, in addition to bank statements and information on any investment accounts.

If you’re self-employed, the income requirements are greater: Two years of tax returns and at least 60 days of current bank statements. The borrower also needs provable liquid assets to qualify and cash reserves equal to six months of the mortgage payments. And all applicants have to show proper documentation on all other loans held and proof of ownership of non-liquid assets (like other real estate objects in your property).

Appraisals

Some lenders may require a second home appraisal for the property that you are planning to purchase. But this is not common.

Home Inspections

General regulations and due diligence are not foreign to this type of financing. So inspections in septic tanks and peeling paint are required here and should be part of the due diligence of prospective buyers.

Also, we include here checking for aluminum wiring and the remediation process required in some cases to bring it up to code through a compliant “pigtailing” or rewiring to copper.

Interest Rates For Luxury Home Financing

While luxury home financing used to carry higher interest rates than conventional mortgages, and this is still the case, the gap has been closing in recent years. Today, the average annual percentage rate (APR) for luxury home financing, performed through a jumbo mortgage loan is often par with conventional mortgages, and in some cases, actually lower.

According to lenders and underwriters that I know from my own business, the reason for these lower APRs is, as we can all imagine, to attract more borrowers for luxury homes. They explained that these borrowers are just the sorts of individuals that institutions love to sign up for long-term products, partly because they often need additional wealth management services, and they can cross-sell them other products such as investment portfolios, mortgage notes, wealth management, and private banking. Plus, it’s more practical for a bank to administer a single $2 million mortgage than 10 loans valued at $200,000 apiece.

For example, Wells Fargo charged an APR of 4.092% on a 30-year fixed-rate conforming loan and 3.793% for the same term on a non-conforming loan eligible for luxury home financing and arranged as a jumbo loan. 

Even though the government-sponsored enterprises can’t handle them, jumbo loans are often securitized by other financial institutions; since these securities carry more risk, they trade at a yield premium to conventional securitized mortgages. However, in reality, this spread has been reduced with the interest rate of the loans themselves.

Tax Deductions Available

Just because you may qualify for one of these mortgage loans utilized for luxury home financing, doesn’t mean you should take one out. You certainly shouldn’t if you are counting on it furnishing you with a substantial tax break, for example.

You’re probably aware that you can deduct the mortgage interest you paid for any given year from your taxes, providing you itemize your deductions. But you probably never had to worry about the cap the IRS places on this deduction—a cap that was lowered by the passage of the Tax Cuts and Jobs Act. Anyone who got a mortgage on Dec. 14, 2017, or earlier can deduct interest on up to $1 million in debt, which is the amount of the old cap.

But for home purchases made after Dec. 14, 2017, you can only deduct the interest on up to $750,000 in mortgage debt. If your mortgage is larger, you don’t get the full deduction. If you plan to take out a $2 million mortgage loan that accrues $80,000 in interest a year, for example, you can only deduct $30,000—the interest on the first $750,000 of your mortgage. In effect, you only get a tax break on 37.5% of the mortgage interest.

That means you should borrow with care and crunch the numbers carefully to see what you can truly afford and what kinds of tax benefits you will receive. With the state and local tax deduction limited to $10,000 a year, due to the same tax bill, a highly taxed property will also cost you more to own.

One other strategy: Compare terms to see if taking out a smaller conforming loan, plus a second loan, instead of one big mortgage loan. It might prove better for your finances in the long haul.

Luxury Home Financing vs. Conforming Loans

The key difference between luxury home financing through a mortgage and a conforming loan is the size of the loan.

However, there are other differences. Among the other factors that differentiate these type of loans from conforming loans we have:

Privacy And Asset Protection

It is possible to pay a premium to protect privacy by closing a sale through a limited liability company (LLC), which is prohibited for Freddie Mac and Fannie Mae mortgages, but absolutely possible in non-conforming loans.

Heftier down payment in luxury home financing

While low down payments are fairly common on conforming loans, jumbo loans are more likely to require a down payment of at least 20%, though some lenders may go as low as 10%.

Similar interest rates

Currently, the average annual percentage rate (APR) for luxury home financing, is frequently the same as with conventional mortgages, or just slightly higher.

APRs here are moving in the range of 3.6 to 4.1 %, very similar to the APRs of conforming loans.

Mortgage rates in luxury home financing may be slightly higher than those on conforming loans, depending on the lender and your financial situation. However, many lenders can offer rates (we refer here to APRs) that are competitive with rates on conforming loans.

Furthermore, some may even offer slightly lower rates depending on market conditions, so make sure to shop around and request several quotes.

Historically, conforming loans are more liquid and are backed by government agencies, so from a supply-side point of view, they’re easier loans to make and the participants do not have to care about factors as notices to homeowners or identity of interest.

But since the crisis, we’ve seen a phenomenon where these non-conforming rates are as low and sometimes lower than rates of conforming loans.

Higher closing costs and fees for luxury home financing

Because these loans are bigger and there are some extra qualifying steps, expect higher costs at the closing table too.

Loan Types in Luxury Home Financing

The legal and financial nature of these loans is a non-conforming mortgage loan, and the loan type is a so-called jumbo loan.

It is technically possible to see in the financial market other figures for these mortgage loans as non-QM mortgages provided by subprime lenders. But there are many documentation requirements for financing luxurious homes and an income history required. These requirements leave these non-QM mortgages out of the equation here.

Also, there could be financing for this kind of loan through a bank statement loan, at least technically speaking. However, bank statement loans rely heavily on the average bank statement balance, and in this type of financing we are discussing here, your bank statements are just one of the loan requirements.

This leaves the jumbo loan, which is a non-conforming mortgage loan, as the financial instrument utilized here.

Whom Is Luxury Home Financing For?

Luxury home financing, as we explained above, arranged through non-conforming mortgage loans, is considered most appropriate for a segment of high-income earners who make between $250,000 and $500,000 a year.

This segment is known as HENRY, an acronym for “high earners, not rich yet”. Basically, these are people who generally make a lot of money but don’t have millions in extra cash or other assets accumulated, yet.

While an individual in the HENRY segment may not have amassed the wealth to purchase an expensive new home with cash, such high-income individuals do usually have better credit scores and more extensively established credit histories than the average homebuyer seeking a conventional mortgage loan for a lower amount.

They also tend to have more solidly established retirement accounts. They often have been contributing for a longer period of time than lower-income earners.

How much you can ultimately borrow depends, of course, on your assets, your credit score, and the value of the property you’re interested in buying.

Hard Money Construction Loans

Hard Money Construction loans

Hard money construction loans were dominated by small shops that managed to compete well (3). Due to simple supply and demand (5), private money lenders were able to charge higher rates and fees because there was a high demand for money and very low supply (6) (8). Wall Street has paid notice to the above-average, risk-adjusted yields that can be generated and has begun participating buying mortgage notes from groups that are originating (9) (10), or by buying established private money companies (4).

Along with the entrance of Wall Street in the hard money construction loan (11), interest rates on mortgages are historically low in the US (1) (14), and also very low in the EU (12) (13), and furthermore, they keep dropping (2) leading to lower yields for lenders.

Thus, private lenders are diminishing their underwriting standards to write loans (15), as in the subprime mortgage crisis (16) and offering higher LTV ratios (17) (18) and even no ratio loans in order to maintain market share. This is because there is more supply of capital in the market, just supply and demand (7).

Hard money construction loans are a specific type of asset-based loans issued by a private lender wherein a borrower receives funds secured by a real estate object through a mortgage contract. These hard money loans differentiate from other mortgage loans in the fact that they have shorter terms and that interest rates are higher due to their inherent significant risk and generally lower underwriting requirements.

hard money loans usually have terms of less than one year and interest rates of 12% to 18%, plus two to five points.

A point is equal to 1% of the loan amount, so if you borrow $112,000 and the lender charges two points, you would pay 2% of $112,000, or $2,240. Rather than pay points at closing, as you would with a conventional mortgage, you may not have to pay points until the home sells with a hard money loan

There are two main types of construction loans: loans for the renovation of an existing project (rehab loan) and loans for the ground up construction of a new project. In this article, we will be focusing on loans for new construction.

Hard money construction loans are for those who need the funds to get their new construction project started but may not be a good fit for a loan from a traditional lender. Construction loans are typically used to finance the renovation, or new construction of residential or commercial real estate.

Upon closing, a portion of the loan proceeds are used purchase the property and the remaining balance is held in an escrow account and disbursed to the borrower as the project is constructed

The most popular new construction loans are conventional bank loans, hard money private loans and SBA loans for commercial real estate. Usually construction loans are higher interest, and shorter term loans. Unlike a traditional home loan, which is based on the fair market value of the home and determined by the home’s condition in comparison to other recent sales, construction loans are based on what the projected value of the residential or commercial property will be once the work is complete.

For experienced investors who are looking to fund the challenging undertaking of building a structure from scratch or finishing a tear-down and gut rehab of a preexisting home, a new construction hard money loan is the ideal way to obtain capital. A new construction hard money loan is a short-term financing option that can be used to pay for the construction of a real estate investment asset. Similar to other hard money loans for construction or rehab projects, a percentage of the capital are disbursed upon the completion of the closing process to cover the lot acquisition and the remainder of the loan is retained in an escrow account. The escrow funds are incrementally distributed at predetermined stages of the project. After the completion of each phase—often referred to as a “draw”—the lender conducts an inspection to ensure the work has been completed before releasing the funds to be used for the next draw. This helps both the hard money lender and the borrower stick to the project timeline and maintain an open line of communication.

Private Money Loans for new construction or renovations, use a portion of the funds to distribute at closing to finance lot acquisition, while the rest is held in escrow.

​These contracts require less underwriting than a conventional mortgage. Flexible underwriting criteria allows investors in new construction to secure funding not available to them through other institutions.

These contracts are concluded quickly. A delay in securing funding could mean missing out on an incredible investment opportunity.

So let´s see basically how the process works

During the underwriting phase of the hard money loan, the builder provides the lender with a scope of work and budget that breaks the project down into phases and specifies how much each phase will cost and how long it will take. All of this is determined in the Draw Schedule.

Later, as each phase of construction is complete, the borrower contacts the lender to inform them that a phase has been completed. The lender then orders an inspection by a 3rd party company who visits the property and verifies that the agreed upon work has been completed.

Once the inspection has been completed and the work verified, the lender reimburses the borrower for the outstanding construction costs. The entire draw process usually takes about 3-5 days to complete.

The rehab budget is used to create a draw schedule, which organizes, appoints, and budgets at which stage of the project certain work will be completed. When a particular phase, or draw, is finished,  an inspection is scheduled to confirm the work has been completed. Once the private money lender receives the confirmation of completion, the funds are distributed.

In other words

A new construction hard money loan is a short-term loan used to finance the construction of real estate investment property. Like other hard money loans for construction or renovations, a portion funds are distributed at closing to finance lot acquisition, and the rest are held in escrow. The construction funds held in escrow are distributed in arrears, or after certain phases of the scope of work are completed. The scope of work is used to create a draw schedule, which designates at which stage of the project certain work will be completed, and at what cost. Once a particular phase, or draw, is complete an inspection is ordered to confirm the work has been done. As soon as the hard money lender gets the confirmation, the funds are distributed. This whole process usually takes about 3 days. This draw process helps both the hard money lender and the borrower by keeping the project on track and within budget.

This entire process usually takes about 3 days. This draw process helps both the private money lender and the borrower on track with the project and spending.

Traditional construction loans are issued by banks typically, hard money loans can be obtained through private investment firms. Hard money construction loans are secured by the real estate to be built and often charge higher interest rates conventional bank loans.

Experience Credit Score MinimumInterest RatePointsAdvance Rate On PurchaseAdvance Rate On ConstructionARVProperty TypesPre-Pay PenaltyExtensions Blanket LoansLoan SizeLoan Terms
High6604.99%–10%0–2%Up to 70% Land Value100%75%Single Family, Multi Family, Mixed UseNoAvailableYes$100K to $2.5M12 Months

New construction hard money loans are asset-backed loans collateralized by real estate. The builder who takes out such a loan is typically unable to secure a conventional loan from a bank, a common issue in today’s construction market. For that reason, he or she is generally willing to pay a higher rate of interest to a private money lender in order to close the transaction. Construction loans often include funds for purchasing raw land as well as for building costs, which are paid out in periodic “draws” once the builder has met some pre-defined milestones. Due to the higher risk associated with these types of loans, the lender will generally require the borrower to contribute some of their own cash or equity to the deal. Additionally, borrowers will often have input into the project plans, particularly relating to the timelines and budgets.

When you obtain a no doc hard money loan, in general, a hard money loan for real estate investment purposes, you also have the option of getting a construction loan, called hard money construction loans.

Hard money construction loans are funds that the hard money lender will lend to you in order to execute the actual project. If you are going to spend a hundred thousand dollars on it, obviously you could have the cash and you could just do the work yourself with your own working capital or you request the lender the constitution of a construction loan.

Now construction loans on hard money loans are a little bit different because they don’t just give you a hundred thousand and just let you go and play with those funds.

What they do is that they hold these funds in an escrow account, an ad hoc account to serve the hard money construction loan, and they give it back to you as reimbursement in a reimbursement item called “draw” or “draws” in plural.

Thus, when the hard money loan is arranged, you, as the investor or borrower (“borrower” is more adequate from a terminology point of view because the lender is also an “investor”) provide a scope of work, as one of the deliverables of the contract.

In hard money construction loans, the borrower promises the lender which activities will be executed within that project and how much each line item will cost, and at what phase you will be doing it.

Due to this concept, the borrower has to perform the renovation work and then get reimbursed for that money spent when the line item activities are approved after an inspection.

For example, you have four different draws, each one $25,000 worth. Thus, you have to show to your hard money lender that you completed that first quarter of your project, have them send an inspector in to look, and make sure that all that work is done, and then they will approve the line item and reimburse your $25,000.

Advantages Of Hard Money Construction Loans

traditional loans for conventional construction are taken from institutions such as banks, while hard money loans are provided by investment groups or investors. The advantage of this form of lending is that it is not impeded by traditional banking procedures, which means that the loan will be granted much faster and also have greater flexibility regarding loan terms.

With most hard money loans, the loan amount is based on the as-is house or lot value combined with repair or construction costs. An additional benefit of a hard money construction loan is that there is no minimum credit score. However, keep in mind that unlike hard money fix and flip loans, experience is essential for an investment construction loan.

Lenders are generally willing to fund up to 70% of the land value and 100% of the construction budget, capped at 75% of the ARV. With interest rates from 9% to 11%, points ranging 1% to 2% and a loan term up to 18 months, seasoned investors rely on construction loans like these for finance their business.

Any seasoned investor knows how crucial a quick close can be. Real estate investing is a growth industry, and good deals move quickly. Experienced hard money construction lenders, can close loans in as little as 48 hours, and have an average close time of 10 days, unlike a conventional loan which takes a minimum of 60 days to close.

When it comes to hard money loans, the overall amount is determined by the combined value of the existing structure and lot along with the anticipated repair and construction expenses. An added advantage of a hard money construction loan is that there is no minimum credit score to be approved for funding. All experienced real estate investors realize just how important a quick closing process can be when it comes to getting a loan. 

Securing a hard money construction loan is vastly different—and more efficient—than the process required to obtain a conventional bank mortgage. First off, there is considerably less paperwork as a hard money loan only requires a few key documents. After you locate the ideal investment property, you will consult with a loan officer and complete our streamlined online application. The loan officer and underwriter will then walk through the deal with you step-by-step and explain the appraisal process should your deal qualify for financing. Next, the hard money lender will generate a term sheet that clearly specifies all of the loan’s terms so there will never be any surprise charges. The loan then proceeds to the closing process, after which you will receive your loan and be ready to start diversifying your investment portfolio.

Approval Process Is Faster

Builders, investors and developers with a strong financial background and access to traditional loans still opt for hard money loans to fund their new construction projects because the hard money loan process is faster and easier in most cases. Hard money constructions loans can close in less than a week, whereas bank closings can take 30 days or more.

Specifically, the application process for a hard money construction loan can take a couple days and the approval process can take up to a week. Those desiring to get a project kicked off, or those on a tight timeline will benefit from this swift financing window. In contrast, conventional construction loans can require extensive paperwork that can cause the application process to last weeks. This doesn’t include the loan processing period which can take another few weeks or longer till closing.

As the real estate market has changed in recent years, it becomes difficult for developers to access the money of traditional lenders, such as banks, in the short term. Documentation, paperwork and lengthy project evaluation are just some of the reasons why bank lending is difficult to obtain. It is a huge advantage of hard money loans because of the time of approval is very short. Hard money construction loans are a great alternative for all developers who need the financial resources to start a project, if they feel they are not suitable as a candidate for borrowing from traditional lenders, or if they need a quick financial injection.

Hard Money Construction Loans Downpayment

Hard money constructions loans have a higher interest rate than the loans you can get at the bank, and they are secured with real estate property. You can expect a hard money loan lender to ask you for your investment in the project. The percentage, in this case, will depend on your experience and the project itself. You will likely need to invest between 10% and 20% of the total project cost. Bank approval can take weeks, even months. It is exactly why a hard money loan is a great thing. In a few days, you can get funds depending on the lender and your project. That is why reliable and reputable developers with excellent credit ratings often opt for hard money loans when they want to start or finish a project quickly.

Ask about the requirements to each lender you contact, for how much of the borrower’s own money must be in the construction project. On a spec loan to a builder, that may run the gamut from no money down to ten percent down with either a free-and-clear or subordinated lot. On a construction-to-permanent loan, you can work with the private-money lender for the construction and then with one of your correspondent lenders to do a rate-and-term refinance out of the hard money construction loan. The private lender will require generally a 20% nonrefundable deposit, which can be rolled into the takeout loan.

Payments And Interest In Hard Money Construction Loans And Some Cons

Although there are many types of loans, it is important to note that this is not like a traditional mortgage where payments are amortized and consist of principal and interest. Hard money loans are generally interest-only, which means that the monthly payment is just the interest due on the loan and does not decrease the overall loan balance.

The payment can either be setup as Dutch, where the borrower pays interest on the full amount of the loan, or non-dutch (also known as “New York Interest”) where the borrower only pays interest on the amount of the loan that is disbursed. When evaluating your financing options, it is important to find a lender that offers non-dutch payment options.

Many short-term construction loans require interest-only payments for the duration of the loan, during the construction period. To calculate an interest only payment, take the construction loan amount multiplied by the interest rate, divided by 12 (months per year). For Example: $600,000 loan amount at 10%. $600,000 multiplied by .10 and divided by 12 = $5,000 per month as the monthly payment.

In these hard money construction loans, you still have to pay a 10% annualized rate and two points on those $100,000 of our example, even though you are not getting that money on day one, but after you complete each of these stages or line items agreed within the work of scope annex of these hard money construction loans.

That is why many borrowers are not interested in hard money construction loans while they are affirmatively interested in no doc hard money loans where the money is provided directly to pay the auctioneer or seller of the real estate object instead of depending on on these stages and their approval.

Because let’s say that you have an inspection done after you claim to have the stage or line item completed and request the reimbursement. The inspector does not agree that you did the work well.

Now you are out of your pocket and you need a fix to work with the money that you may not have because you’re over-leveraged versus the situation of the investor that has the capital in cash, and he could just fix it himself.

The worst part again of these hard money construction loans is that the lender charges you on day one. So let’s say you get your loan on January 1st; they will charge you that 10% interest on your hundred-thousand dollars even though you might not even get your draws until March or April which is a lot of time to wait.

Interest Rate And Origination Fee

Now there is a balance between your interest rate and your origination fee and some constructors or borrowers would say that if you are going to execute a very fast project, you should go for a lender that will give you a loan at a very high-interest rate but very low origination fees.

If you will complete your project in just one month, who cares what the interest rate is? Annualized, it is very low.

However, if the points, the interest you will pay, are fixed, with disregard of your completion date, it may not be worth it.

Requirements To Obtain A Hard Money Construction Loan

In hard money construction loans, the requirements that the borrower must meet are not as straightforward as the requirements for conventional mortgage loans, such as FHA mortgage requirements. Let´s see

Familiarize yourself with the builder’s or subcontractors’ draw process. Individual private lenders can be more liberal and pay a builder directly after a site inspection. This is not the norm, however, and a larger lender will require that a title company be involved and pay the builder and subcontractors directly after lien waivers are received. Contact your local title company to see if it is doing any new construction loans, and if so, familiarize yourself with the lien laws in your state.

In order to get approved, the borrower will need to have completed architectural plans, engineering, budgets, and a scope of work. Plans, engineering, and fees are generally referred to as “soft costs” and some lenders will allow the borrower to finance those into the overall loan. 

Hard Money Construction Loans

Once the borrower has the necessary plans and entitlements, they will fill out an application with a hard money lender. In addition to the application, the lender will want to know the borrower’s credit score, any previous experience, and the plans and scope of work for the project.

Based on that information, the lender will then issue a term sheet to the borrower that outlines the loan terms under which the lender is prepared to offer a loan. These terms can vary, but usually range between 70% and 85% LTC (Loan to Cost) based on the overall project budget. This means that the borrower will be responsible for paying closing costs as well as 15% to 30% of the cost of construction.

Once the borrower accepts the terms, the lender will order an appraisal of the property from a licensed appraiser. While the appraiser is conducting the appraisal, the lender collects any outstanding items and makes sure the file is complete. Once the appraisal is compete and approved, the lender will complete the final underwriting and fund the loan.

Loan terms can vary depending on each project and hard money lender but typically the loan terms for construction & development typically consist of the following:

  • Up to 75 percent loan to value ratio on commercial construction loans
  • Up to 85 percent loan to value ratio on residential construction loans
  • Up to 85 percent with a mezzanine loan or preferred equity
  • Up to 36 months loan term
  • With provisions to roll into a permanent mortgage
  • Non-recourse construction loans available on business loans
  • Fixed interest rate

When you get a hard money construction loan, the lender is going to ask for some information. Anyway, for the most part, they would be looking at the property itself.

Obviously, the lender wants to see the address of the real estate object, and this will be studied by the underwriting team.

You, as the borrower, will have to justify why you think that this is a good deal to them.

Payments Of Interest

Most hard money lenders expect interest-only payments monthly while the loan is outstanding, but some may allow the interest to accrue and not require it to be paid until the flip is complete. It might be worth asking your lender if you can wait to pay the loan interest until after you sell.

Many short-term construction loans require interest-only payments for the duration of the loan, during the construction period. To calculate an interest only payment, take the construction loan amount multiplied by the interest rate, divided by 12 (months per year). For Example: $600,000 loan amount at 10%. $600,000 multiplied by .10 and divided by 12 = $5,000 per month as the monthly payment.

First Position Lien

A hard money lender, similar to a bank, will hold the first position lien on the home until the borrower repays the loan. Still, the borrower will be the owner and hold the deed, of course.

Location

A private lender will only underwrite a new construction loan if the site location is available for the construction of real estate objects.

 In order to qualify for a construction loan, the property must already be entitled for the type of building that the real estate investor wants to construct.

If the purchase and repair cost vs. the resale value makes sense and the borroweris trustworthy, a hard money lender will make the loan.

Hard Money Construction Loan Limits

No legal limits as the FHA loan limits, for example. I see that the maximum for a loan of this type is three million dollars, with a modal average of less than a million.

Downpayment

If you are a lender, you will be looking to ensure that your prospective borrowers are equally prepared to contribute some capital to the project as well. The fact that you will have cash readily available for the construction project as a downpayment shows that the project is both serious and is worth risking a down payment to get the loan you need to finish the construction.

In evaluating the borrower, hard money lenders aren’t usually worried by borrower qualifications such as debt-to-income ratios. In some cases, they may want to see an applicant’s documents such as tax returns, bank statements, and credit reports. Nor do they care if down payment funds are borrowed.

Good Credit Score

The lender will require you to have a credit score of about 630 or above. Under 630, they will charge the borrower with a higher interest rate, more points, or they may not grant you the loan at all.

Borrowers with credit scores lower than 680 will be able to borrow slightly less and will pay the highest costs. The minimum credit score is 630.

Debt To Income Ratio

It is generally speaking, a no ratio loan, as the debt-to-income ratio is is not a parameter that I see that the hard money construction lenders are taking into consideration.

Lot Lien

Know whether your lender is comfortable with including some or all of the lot cost in the loan. Ideally, a lender wants a lot to be free and clear or at least subordinated to the first-position private-money deed of trust. Some lenders may fund as much as 70 % LTV of the appraised value and allow some of the lot cost to be funded into the deal.

Scope Of Work

Unlike other mortgage loans, in hard money construction loans, the lender wants to have a scope of work, which is a document issued by the borrower. They want to see what kind of work would be performed on the property, with the actual numbers attached to it. Therefore, it is good to get a contractor to come by, take a look at the property, and give you an accurate bid before you actually get a hard money construction loan.

Experience In Construction Projects

The borrower will require to see the experience that you have obtained in different properties in the past. Is this your very first project, do not lie. Tell them the truth, but if you have more experience, let’s say five projects or more in the past two years, they’re gonna give you a significant discount and a better LTV ratio because they will trust you more, and they think that you are able to do the project as you said you will. I prefer to always work with the same lenders in hard money construction loans because I receive better conditions.

Rates And Fees

The typical builder who used bank financing in the past may balk at a six-month loan with a 12 percent interest rate and 4 points, for example, but you must show them the profits they can make on a deal that is consummated, rather than waiting on the sidelines with no funding.

For a presold loan, if the end loan costs are rolled into the deal and 5 percent to 10 percent of the project’s equity is allocated for points and fees for the new construction deal, then the clients may be happy they can get a project under way and completed, and often in a shorter time frame than traditional financing.

Bank Statements

The lender might want to see some bank statements from you. Probably from the last one or two months, or more commonly, the last three months. With this, you will show your liquidity, meaning the money that you can use right away. Less liquid, but also admissible, are stocks, bonds, mutual funds, or straight-up cash, as we described before.

Assets To Pledge To The Hard Money Construction Loan

The lenders are not interested in the real estate you own, because you are not going to be able to sell your real estate and use that as cash right away. Thus, the lenders will be watching mostly at liquid assets: so watching liquidity down-payment, construction costs, closing costs, and six months of your monthly payments

Tax Declarations

Likewise, in hard money construction loans, the lenders are not interested in your tax statements at all, and this is one of the reasons why these loans are called no doc hard money loans too.

After the requirements are met, normally these hard money construction loans are wrapped up and closed in about 10 to 15 business days, and they can probably go even faster in some cases.

Construction-to-permanent Loans And Hard Money Loans

As with most hard money loans, private construction loans are intended for builders and real estate investors that do not intend to occupy the property as their primary residence once it is complete. Therefore, hard money construction loans are not intended to be used by consumers who want to build their dream house. For owner-occupied borrowers, a construction-to-permanent loan might be a more suitable option.

Most often, construction loans are used by experienced builders to quickly and seamlessly finance construction of single family spec homes, apartment buildings, or subdivisions.

Business Case For A Hard Money Construction Loan

So here the business case that I would like to explain to you is the case of a loan required to finish an existing project. The borrower has already started the project and is in a stage where the requirement arises.

Would a hard money lender be willing to give the borrower a hard money construction loan of $100,000 for the completion of an ongoing project, if the project got to that point and the borrower needs a loan to finish the home?

Answer

Yes, there are several hard money lenders who would lend $100,000 for the purpose of construction completion and they could issue the loan in less than one week.

Pricing would probably come in at the following terms:

  • $100,000 Loan Amount
  • 9.99% Interest-Only
  • $833/mo Monthly Payment
  • 12 Month Term
  • No Prepayment Penalty

For this situation, the total cost of the new home she was building would be approximately $400,000. A hard money lender would be okay with a small $100,000 loan against a $400,000 home because it’s a very safe, low Loan-To-Value (LTV) loan.

One requirement that a lender may ask of the homeowner is that the loan is paid off as soon as the construction is completed. The reason they might include this language in the terms is that most hard money lenders will not finance consumer loans, especially owner-occupied loans. And once the home is completed, the homeowner will be moving into the home to occupy as their primary residence and will need to obtain permanent financing.

Many hard money lenders don’t want to take the regulatory risk of having a loan on their books that they know will be dancing around the federal and state regulations or the covenants of their fund, which often excludes owner occupied 1-4 unit consumer loans.

The best thing a homeowner could do if they had a hard money construction completion loan requiring payoff when the home is completed is to refinance into a conventional (Fannie Mae or Freddie Mac) loan. The pricing would be much better than the hard money loan. At today’s conventional mortgage rates, they’d probably be able to get a $100,000 at a rate just under 4.00% where the PI payment would come in around $470/mo.

In summary, if this homeowner building a custom home and runs out of money, a hard money lender would gladly step in and lend the investor the remaining $100,000 to complete the project. And this could happen in less than one week.

Let´s see another case

Hard money lenders base the amount you can borrow on the home’s after-repaired value (ARV).6 If a house costs $80,000, but the ARV is $160,000, and you can borrow up to 70% of ARV, you can borrow $112,000. After paying the $80,000 purchase price, you’ll have $32,000 left for closing costs (though you might be able to negotiate for the home’s seller to pay them), lender fees, rehab, carrying costs, and selling expenses. These include items such as staging, marketing, and real estate agent commissions. If you can stick to that budget, you won’t need any money out of pocket to flip the home.

The $2,240 in points will take up a significant chunk of that $32,000 budget, though, and if you’re paying 15% interest for six months, your total interest cost on $112,000 will be $8,400. After these two significant expenses, you’ll have just $21,360 for everything else—less if you had to pay closing costs. But if the home does sell for $160,000, you’re looking at a $48,000 profit, minus taxes, for six months of work, potentially without writing a single check from your bank account.

Risks In Hard Money Construction Loans

Even if you qualify for a loan with a down payment, you’ll pay more when you’re borrowing for a hard money construction loan than when you are borrowing to buy a primary residence. That is because hard money lenders see these projects as a riskier proposition.

From sudden increases in the cost of materials during construction to environmental and structural issues like unsuitable soil, infestations, hazardous conditions or other issues discovered along the way, unwelcome surprises during a construction process can increase construction expenses and threaten adherence to a scope of work schedule.

Due diligence activities at the front-end of the design phase, such as a Phase 1 Environmental Site Assessment, a Geotechnical Site Investigation and builder inspections can help to identify potential issues early in the project so they can be resolved or avoided from a budget and schedule standpoint. Employing a design-contractor team to manage these due diligence items is a smart means of managing project risks and preserving cash resources.

Process To Close A Deal

The process of securing a hard money construction loan is much different than that of a conventional mortgage. Unlike a conventional loan, which requires a significant amount of paperwork, a new construction loan requires relatively light documentation. Once you have completed the new construction loan application, the loan officer and underwriter will review the deal with you and order an appraisal if the deal fits! The underwriter will ask questions about your experience, as well as request copies of the construction plans and other relevant documentation. From that point, the lender will issue a written term sheet that outlines all the loan’s details so there are never any hidden fees. The loan then moves to processing where the few required documents are collected, and ultimately the loan is closed by an attorney.

Upon closing, a portion of the loan proceeds are used purchase the property and the remaining balance is held in an escrow account and disbursed to the borrower as the project is constructed

Available Variation Types Of Construction Loans

Construction-to-permanent loans. These loans are good if you have definite construction plans and timelines in place. In this case, the bank pays the builder as the work is being completed. Then, that cost is converted to a mortgage at closing. This type of loan allows you to lock interest rates at closing, which makes for steady long-term payments.

Construction-only loans. Construction-only loans must be paid off in full once the building is complete. It’s a good choice if you have a large amount of cash to work with or you’re confident that the proceeds from the sale of a current property will cover another build. Here, if you need a mortgage to cover the cost, you’ll have to search for the lender yourself and be approved a second time.

Renovation construction loans. This type of loan is used if you’re buying a fixer-upper. In this case, government programs are available and the projected cost of any renovations you plan on doing to the property is wrapped up in the mortgage, along with the purchase price.

New construction loans are usually long term loans aimed at spacing out the total cost to build or buy new construction units over a span of 5 to 25 years.

Hard money construction loans typically last no more than a few years.

Construction Projects Suitable For Hard Money Construction Loans

There are several different types of new construction projects that would benefit from access to hard money. These projects are initiated by individuals, homeowners, corporations, other business entities, non-profit associations, privately funded schools, hospitals, publicly traded companies, etc.

Construction projects come in all different shapes and sizes, and include:

Residential Construction. Construction work that is being performed on a single-family residence or a residential dwelling with less than 4 units. Apartment and condominium complexes would most likely be considered a commercial project unless it only consists of a few units and the owner occupies one.

Commercial Construction. This is the construction of any buildings or structures for commercial purposes, including restaurants, grocery stores, high-rises, shopping centers, sports facilities, hospitals, schools, etc.

Industrial Construction. This is a niche segment of the construction industry. These projects include power plants, manufacturing plants, solar wind farms, refineries, etc.

Role Of The Broker In These Loans

To receive compensation for their work, brokers must demonstrate that they have brought value to their side of the transaction.

For builders or homeowners, you have connected them with a source of funds for their transaction that would be difficult or impossible to close at a bank.

For the private lender, the broker adds value by presenting a full package with 1003 and supporting financials, so the underwriting of a potentially profitable deal can proceed efficiently and effectively.

I would suggest the broker to work closely with the lender to have the compensation tied to a front-end closing, monthly payments or when the hard money lender gets paid off. The compensation will increase or decrease according to how long the broker that participated in the hard money construction loan is comfortable waiting to get paid.

No Doc Hard Money Loans

no doc hard money loans

The no doc hard money loans mortgage market has greatly expanded since the 2009 mortgage crisis with the passing of the Dodd-Frank Act. The reason for this expansion is primarily due to the strict regulation put on banks and lenders in the mortgage qualification process. The Dodd-Frank and Truth in Lending Act set forth Federal guidelines requiring mortgage originators, lenders, and mortgage brokers to evaluate the borrower’s ability to repay the loan on primary residences or face huge fines for noncompliance. Therefore, no doc hard money lenders only lend on business purpose or commercial loans in order to avoid the risk of the loan falling within Dodd–Frank, TILA, and HOEPA guidelines.

From inception, the hard money field has always been formally unregulated by state or federal laws, although some restrictions on interest rates (usury laws) by state governments restrict the rates of hard money such that operations in several states, including Tennessee and Arkansas, are virtually untenable for lending firms

A no doc hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by real property. They are typically issued by private investors or companies. Interest rates are typically higher than conventional commercial or residential property loans because of the higher risk and shorter duration of the loan. A no doc hard money loan is therefore a type of loan that is secured by real property. These loans are primarily used in real estate transactions, with the lender generally being individuals or small companies and almost never regulated banks.

Pros And Cons Of No Doc Hard Money Loans

Most no doc hard money loans are for only three to four months. They have very high-interest rates compared to a traditional thirty-year amortized mortgage, but they are utilized because they allow the borrower to purchase properties that normally could not be afforded or would require a longer contract negotiation.

For example, suppose a property that costs at least a million dollars and most people just do not have a million dollars in cash, and if they had to go through a traditional route of obtaining a long-term mortgage, it would take over a month to close escrow.

In no doc hard money loans, the deal is only possible because the auctioneers or sellers are in some kind of financial distress and the prospective buyer is able to close quickly on these deals with the financial support of the lender.

Being able to use no doc hard money loans allows the borrower to purchase a property and close the operation within ten to fifteen working days, whereas a traditional loan can sometimes take over thirty days.

Interest In No Doc Hard Money Loans

The interest rates on hard money loans are typically higher than the rates charged for traditional business loans. Rates could be as low as 6% and as high as 14% or more.

Despite this, such loan options are popular among real estate investors for their fast approvals, higher flexibility, less extensive documentation procedures, and because they are sometimes the only option for securing funds.

Costs Of No Doc Hard Money Loans

Typically, if you are brand-new in the real estate market, then you probably cannot get as much leverage as an experienced investor can, so you are looking at obtaining no doc hard money loans at 85% LTV or 90% LTV at the best.

What does that mean is that if your loan to value ratio is either 85% or 90%? For example, if you have a million-dollar property, then the maximum that someone will loan you is either 850 thousand for an eighty-five percent LTV or 900 thousand if it’s 90 percent LTV. The remaining money should be brought by the borrower as a down payment.

Now, what does it cost to get no doc hard money loans? Well, for a brand-new investor you are typically going to see rates at ten percent annualized and two points for the origination. That means for your $90,000 loan a ten percent of that nine hundred thousand is due every year and an annualized rate, so after holding that loan for a whole year you have paid ninety thousand dollars in interest payments.

Yes, that sounds like a very expensive deal and much worse than a traditional long term mortgage, but it is worth it for the investor who is going to make two hundred thousand dollars on the back end.

Origination Fees As A Cost Of The No Doc Hard Money Loans

What are origination fees? Origination fees are about 2% of the no doc hard money loans and are the fees that the hard money lender charges you to originate the loan. The origination here means to create the loan for you, so using “creation” as a synonym with “origination”.

The no doc hard money lenders have people working for them in the back-office underwriting the loan, salespeople who are creating the packages for the borrower, lawyers drafting a contract, and working with you to close on time. All these back-office services cost money and finally the borrower will be paying for them in a line item called “origination fees”.

Most of them are 2% for new investors so for on a $900,000 loan on a 1 million dollar property and 2% origination fees you will be paying $18,000 just to close on the loan.

But they do not charge you directly this 2% of origination fees. What they actually do is that they just give the borrower a smaller loan, so instead of giving the investor that $900,000 loan expected, they are going to give the borrower a loan for $882,000 (eight hundred eighty-two thousand dollars).

Usually, the consequence of this is that the borrower has to come up with more money to close on the property in the first place.

Difference With A Bridge Loan

Most no doc hard money loans are used for projects lasting from a few months to a few years. Hard money is similar to a bridge loan, which usually has similar criteria for lending as well as costs to the borrowers.

The primary difference between a no doc hard money loan and a bridge loan is that a bridge loan often refers to a commercial property or investment property that may be in transition and does not yet qualify for traditional financing, whereas hard money often refers to not only an asset-based loan with a high interest rate, but possibly a distressed financial situation, such as arrears on the existing mortgage, or where bankruptcy and foreclosure proceedings are occurring.

Down Payment Required

So when you come as an investor/borrower to a closing table, what kind of funds do they need you to have when working with no doc hard money loans?

Obviously, they want the borrower to have the 10 percent or 20 percent as the down payment for the property, but you also are required to possess enough liquid capital to pay for the origination fees.

Furthermore, you are required to possess enough working capital to pay for all other buyer-closing costs like notary fees and other miscellaneous items that they charge the borrower when closing the deal for the property. Many borrowers include these miscellaneous items inside the origination fees line item.

Prepayment penalties

When you are considering to enter into no doc hard money loans, you also have to be careful if they have a prepayment penalty.

Sometimes they will charge you for a predetermined number of months of payment regardless if you close the no doc hard money loan through a complete payment in one or two months.

Therefore, so some investors or borrowers do something called “wholetailing” where they buy a property with a no doc hard money loan, and they put it back on the market without doing anything, and they sell it within a short period of time.

If you have a loan that has a four-month minimum that you have to pay those four months’ worth of interest payments no matter what, that is a contract clause of prepayment penalty.

Hence, just be careful when you are getting a loan of this type to ensure that there is no prepayment penalty within the terms defined by the lender, or if there is such a clause, that it does not affect you because you have planned to spend a long time working on that project, presumably, a construction or renovation project, anyway.

Thus, no doc hard money loans are typically for the real estate business and specifically for house flippers, people doing fix-and-flip.

Complete Business Case From The Investor Point Of View

No doc hard money loans can be understood much better if we describe a complete step-by step business process life cycle starting from a prospective investor or potential borrower who is interested in a real estate object that requires a lot of renovation or that can be rearranged completely during an auction. This is the typical profile of our readers, by the way.

What usually happens in the real estate business is that the investor desires to flip a house and earn money from that operation.

The investor finds a property at a $250 000 purchase price at an auction, and he needs to close very quickly on this house, otherwise, the auctioneer may close the deal with another buyer.

Unless this borrower has 250 000 cash in his pockets to put down, he will require another source of money and that is usually where hard money lenders step in and the entire no doc hard money loans business approach appears, in opposition with traditional long term loans.

Typically, hard money lenders can obtain money for these investors very fast. Sometimes it is five to ten days, the time period in which they can have the money in your pocket or better said, available for you.

If you have a relationship with these lenders, what you will normally have after your first project working together, they can close in three to even five days or give you a proof of funds for you to move forward with the seller or auctioneer.

You can really work with them to be your financial partner to make sure you grab the best hammer price at the auction, so they specialize in the speed of getting deals done fast.

Now, why are they called no doc hard money lenders? Where is “hard money” coming from? It is because their terms and conditions are quite higher than usual. It is hard money because it is a little bit expensive money, however, it gets the deal done for the borrower.

The borrower will not care much about the higher interest rates of no doc hard money loans, because the deal can be closed faster with the seller or auctioneer.

So for example on this 250 000 dollars house from our example, let’s say they do a hundred percent of the deal (100% LTV in our hypothesis, but more typical is to find an average of 70% LTV) to purchase the home.

Your plan, as an investor, is to perform the renovations of the house spending, let´s say, fifty thousand dollars ($50,000) in renovations and you will sell it for four hundred thousand dollars afterwards.

Therefore, you bought it through a no doc hard money loan for the aforementioned 250K, you are going to put 50 grand in ($50,000) and you are going to sell it completely refurbished for $350,000. This represents earnings for $50,000 on this transaction, before taxes.

Back to the example. So the property has a price of 250k. You will invest in the renovation for “flipping” purposes 50k from your own money or a line of credit from the lender that is another loan that is for construction purposes.

After the renovation, you sell it for 400 thousand dollars. Thus, if you invested 300k (250k of the price of the house and 50k in the renovation), you have earned 100k of profit.

However, of course, you have to pay the borrower, closing in that way the different positions that could exist in the mortgage loan in case that there is more than one creditor.

You pay the borrower the principal amount of the no doc hard money loan that is 250k and now you have to pay their fees.

You have already paid, in our example, three points upfront. Thus, you have already paid the 7 500 upfront.

Apart from the “points”, that is the interest percentage paid in advance, now you also have to pay the 11 percent interest annualized. As our flipping life-cycle was performed in six months (acquisition of the real estate object + asset renovation + sell of the asset) so that would be 5.5 percent on the base capital of 250 K, which is $13750.

You pay them $13750 and the obligation is concluded. The hard money lenders have their money back after six months and the investor had an EBT (earnings before taxes) of about 80K from this deal because the borrower/investor paid at the beginning 7 500 (the “points”). Later on, the investor paid 13,750 as the interest rate.

This is how a no doc hard money loan is closed. The investor now, has a relation established with the lender and would start another “flipping” project and partner again together. This time, the investor would request a higher LTV, surely moving from 70% to 80%.

Mortgage Loans In No Doc Hard Money Loans: Requirement of a First Position

The lender will normally provide the funds to the borrower with the condition that he takes the first position on the mortgage of the property.

There are exceptions to this situation that will be studied below. But in almost all cases, the condition of the no doc hard money loan is to take the first position in the mortgage loan.

I will explain to you now how positions work in mortgages derived from no doc hard money loans. For the mortgage creditor, the first position on the property means that in the capital stack, they get paid out first.

There can be more positions such as second and third position. These positions define the level of priority of the mortgage creditors.

What that means is that if the house or real estate object goes into foreclosure and gets sold, the first position person gets paid a hundred percent first.

Regarding the mortgage creditor’s second position, if there is leftover money, then gets paid some leftover, and then the third position continues according to the priorities in the capital stack.

As we go down in the capital stack, the price of money gets more and more expensive because the prospective creditor who will assume the second position is engaging on a much higher risk. A first position mortgage right now is like a 2,5% up to 3%.

For a second position they might charge you a four and a half percent up to 6% and then a third position can be easily more than 10%

For example, a no doc hard money lender, who can provide you with 250 grand ($ 250 000): they want a first position on the mortgage, meaning they essentially “own the house” (not legally, of course, as the “house” is the collateral of the mortgage and is still in the property of the debtor).

If the debtor does not pay them back they are just going to “take the house themselves”.  The lender will legally repossess the real estate object due to nonpayment in a process that can be judicial or not.

For American flippers doing this process in the European Union, a trend growing since 2021, the only difference is that all foreclosures are strict foreclosures in the EU, all are judicial, so there is no repossession, and the borrower at fault is given a period of fifteen working days to pay or to oppose limited exceptions to the foreclosure. The process is done in a Civil court (like a divorce process) and the process is called “mortgage execution”.

So back to our case, the hard money lender wants to be in the first position. He would usually not take a second position in the mortgage loan because it is too risky.

If you take a second position as a lender, you are at the mercy of the first position lender. The first position usually has all the rules and rights to decide what to do so if they do not want to sell, they do not sell.

Likewise, if they want to hold on and do nothing, or just renovate or upgrade the house taking two years for that, they have pretty much all the decision-making on from that first position. In these cases, no doc hard money loans are like a traditional loan.

However, we will see below that some investment funds enter into these no doc hard money loans to take a second position

Difference Between A Bridge Loan and A No Doc Hard Money Loan

Investment Funds Take the Second Position In The No Doc Hard Money Loans

Some investment funds only enter in the second position of the mortgage loan lender stack.

They do this to buy out the first position afterwards. So what I mean by that is this: they will come in, and they will arrange a loan with the borrower of, for example, five hundred thousand dollars.

They buy out the first position lender for less money than these 500 k of our example. For example, they will buy out the lender for 300 k.

So that is one way that a lender can get into a deal even if there is already a first position on it. They will just buy out the first position and assume the first position themselves. I see this approach in the market and it is done normally by investment funds and not by private lenders.

Determination of The LTV Ratio

Because the primary basis for making a hard money loan is the liquidation value of the collateral backing the note, hard money lenders will always want to determine the LTV (loan to value) prior to making any extension of financing.

A hard money lender determines the value of the property through a BPO (broker price opinion) or an independent appraisal done by a licensed appraiser in the state in which the property is located.

The loan amount the hard money lender is able to lend is determined by the ratio of loan amount divided by the value of the property. This is known as the loan to value (LTV). Many hard money lenders will lend up to 65–75% of the current value of the property. There is no such thing as 100% LTV for this type of transactions. These loans are meant for investors and the lenders will always require a higher down payment.

Typical LTV Ratios In These Loans: 70%

A hundred percent loan-to-value ratio (expressed as 100% LTV) is a ratio which from the lender’s point of view is very risky and they do not exist in the market.

Why not 100% LTV? Because, what happens if this house drops its price? imagine that the entire stock market drops 20 percent overnight? The borrower, who did not invest any money in this 100% LTV example, would simply walk away from the deal. The lender, instead, they will have their rights in the collateral, but they may also have losses that are about twenty per cent or a bit more.

That is why you will not see in the market 100% LTVs. More common could be an 80% or even more frequently, a 70% LTV.

In this case, the lender will grant the funds to the borrower up to a 70% of the purchase price, assume fewer risks, while securing themselves the first position in the subsequent mortgage loan. The investor or borrower has to perform a down payment of 30% of the purchase price and will receive the funds to enable the purchase from the seller or auctioneer.

In this way, the lender ensures that the investor does not walk away from the property because he has a good 30% of his own money in the property.

Once the hard money lenders know you well because you have been working together in the past, they could be doing a 100 loan to value for arranging a no doc hard money loans.

However, in general, they are very cautious at the beginning because, despite the foreclosure rights, the lender will seize the property (“repo the house”), the house has to be put on sale and probably accept a loss.

The previous evaluation depends on the hard money lender you are working with. If you have worked in the past with the lender, he may take more risks and go with a 90% LTV for the following no doc hard money loans.

Fast Turnover and the Internal Rate Of Return In No Doc Hard Money Loans

For this topic, we continue with our example: The lender provided 250 thousand dollars to the investor while securing themselves a first position in the subsequent mortgage loan. The investor plans to invest in the home renovation about 50K, reselling it for 400K and obtaining a good revenue thereof.

Lenders of no doc hard money loans typically want the investor to complete this “flipping life cycle” short term. They do not want to engage in a contract for over a year because it hurts their returns, it hurts their IRR (Internal Rate of Return). The faster you receive back the money (velocity rate), the higher the IRR you obtain.

Some lenders will want a monthly payment while some lenders will say: “I want a balloon payment at the end of six months“, so six months and one day “I want my 250.000 of my loan back, plus my interest rate of 12 percent“.

The faster the turnover, the better for the no doc hard money lender.

no doc hard money loans
House typically object of no doc hard money loans. Auction from March 2021

Typical Contract Terms In No Doc Hard Money Loans

What are some typical contract terms that these no doc hard money loans have in common?

  • The “points” (Modal average found in no doc hard money loans are three points)

A lot of no doc hard money lenders will propose this: they will require three points and 11% interest. Therefore, three points of 250k (3% points) would be seventy-five hundred dollars ($7500) they want upfront.

  • Insurance and legal documents

You can negotiate with them who is going to pay for the title insurance, and which party will pay for the legal documents.

Sometimes that is inside of the terms of the contract. They will say that of the $7500 they will cover the legal documents, but you will cover the title or vice versa.

  • Interest (average is 11%) of the no doc hard money loans

And then we have 11% interest and this value depends on the lender. Sometimes they request 11% with disregard of the full payment of the loan, whether it is in six months, or three months, or two months

More common is to define an 11% interest annualized.

If the investor has completed the flipping in only six months, that really means that the borrower is paying 5.5 % because it is an annualized number.

As we mentioned, these terms in no doc hard money loans depend on whom you are dealing with and whom you are talking to, or from a lender’s point of view how this lender wants to pitch the proposal of the deal.

For you, as an investor, you can simply find another no doc hard money lender if you find out that the lender imposes you a high-interest rate, a very low LTV rate (less than 70% LTV) or is imposing you to pay the administrative expenses of the arrangement of the loan.

Just ensure that the lender you choose can put the money in your pockets in no more than seven working days.