What Is A Hard Money Loan?
Hard money loans are financial tools for sophisticated buyers who need to take drastic measures to secure real estate. The sources of such secured lending are usually private investors or syndicates of investors; this type of lending usually has a one-year term; this might extend up to five years in extreme cases.
Hard money is a resource that discretely supports real estate investment and development in communities across the country. Investing in debt secured against real assets is one way that investors can earn income from their capital. It is also one method that developers and real estate investors can use to get the leverage they need to purchase the assets they believe will increase their wealth.
Why Use Hard Money?
Hard money investors put up the cash for properties based on their experience and knowledge of the market. A hard money transaction is a contract that funds real estate purchases in return for a defined rate of interest, points, and other terms stated in the contract.
It is a method to get access to funding for real estate that is faster than the conventional route of applying to a bank or mortgage company for the funds. In return, hard money lenders charge higher rates of interest that reflect the perceived greater risk involved.
Hard money loans can be a way to secure real estate deals that just cannot wait. You might find a property to fix up and flip for a quick profit; hard money would be suitable in this case. Other instances would be for construction loans, land loans, where your credit history might preclude lending or you just need to move quickly to secure a bargain offered by a motivated seller.
What Do Hard Money Lenders Want?
Lenders focus on the value of the real estate property against which you will secure the loan, but they will expect you to have equity in the property. For example, if you own land and wish to build on it to sell at a profit later, a hard money construction loan will add to the value of the undeveloped land.
If you have cash for a significant down payment, and you need financing, but cannot go the conventional route for any of the reasons discussed above you can borrow the funds you need from a hard-money lender.
Lenders will provide two-thirds to three-quarters of the equity in the property. Some investors may consider the extra value added by improvements but most will take a conservative stance and would demand interest rates of fifteen percent or more and as much as six points to extend more than the basic. An Internet search will reveal who the local lenders for hard money are in your area. You may also find them at local investment club meet-ups.
The Hard Money Reality
Hard money is not for everyone; if you have the time and financial resources to source conventional lending, then you most likely will not choose it. However, if you need funding quickly to close at a discount to market value, or you just have no other source of finance, hard money lenders can make the deal happen for you at a price. Used wisely, hard money can be an excellent tool for making deals happen in investment real estate.
Should you divert funds from your down payment to get better terms on your monthly payments? Or should you go the opposite direction and add to your equity? How about getting cash back at closing? These are all things that you can do by adjusting the level of discount points that you agree to pay at the start of your new home loan.
Purchasing A Discount On Your Home Loan
The American system of mortgage lending and home lending is unique because of one valuable feature: The ability to pay points in advance, to control the repayment interest rate. By setting up a payment at the start of the loan period, lenders and borrowers have the flexibility to negotiate terms where they might otherwise not be able to come together in agreement on prices and other details.
The more you pre-pay as points, the lower the interest rate that your lender will allow. Conversely, if you are willing and able to withstand higher payments but you have little or no cash for your down payment, you can use negative points to supplement your deposit. Depending on what your lender offers, one point is equivalent to about a quarter percent in interest on your loan.
Your Discount Points Options
So, do you pay discount points? Or finance without points or do you go negative? A point is worth the equivalent of one percent of your loan and a discount for points will reduce your payments over the long term. Points are tax deductible and down payments are not.
If you put the funds into down payment instead of discount points, it could allow you to avoid buying private mortgage insurance. Depending on how close you are to gathering the cash for a substantial down payment, you may want to use negative points to get to twenty percent of the sale price. It will mean that you do not have to make monthly PMI payments, which will save you significantly on your monthly payment.
Going Negative On Points
Negative points might add a quarter of a percent to your rate for each negative point that you take, but it could give you the funds to increase your deposit or pay for closing costs. Negotiating the points you pay is one of the tried and true techniques that investors have been using for years, and it has the potential to secure investment properties or as your home.
However, it does hold moderate risk; if you intend to stay long-term, you will save money on monthly payments by refinancing as soon as you have the equity to do so. The experiences of the last dozen years in real estate show the extremes at both ends; we can see that the market can boom, or in the worst case, the market can collapse.
The uniquely American feature of discount points in real estate finance is an option that has more flexibility than most borrowers realize; you can negotiate the points you pay, not pay them at all, use them more creatively to secure the property that you want. Use home loan discount points to your advantage and you are one step closer to being the master of your real estate realm.
Options For Financing Rehab And Home Repair
When you buy a home, whether to occupy or as an investment, no lender is going just to give you cash at closing and hope that you do the right thing; being smarter than that is how they stay in business. Fortunately, if you do need to find some cash to renovate or upgrade the property once you take ownership, there are a couple of options available to you.
If you hope to get cash at closing for home renovations, your best bets are either an FHA 203(k) program home loan or a Fannie Mae HomeStyle loan. Both of these programs provide practical solutions to funding your home upgrade and protect the interests of the lender at the same time.
The FHA 203(k) Home Improvement Loan
Section 203(k) Rehab Mortgage Insurance from HUD allows buyers to purchase or refinance, and rehab a property simultaneously. This policy insures up to the final, rehabilitated value so that borrowers can pay a discounted price and adds the value through repairs and refurbishment.
The cost of rehab must be at least $5,000, and the FHA mortgage limits still apply to the final value of the revitalized home. HUD provides a list of the permitted repairs, which range from the simple to the drastic. You can essentially rebuild a structure using this program. The Section 203(k) program is available through FHA-approved lenders.
There are some drawbacks to this program: Not all properties will qualify, there are funding limits, and the application process is complicated. Even so, they make repairs affordable, and the down payment requirements are low, in line with FHA lending.
The HomeStyle Loan From Fannie Mae
Fannie Mae offers something like a construction loan with the HomeStyle Renovation loan. This facility is available for purchasing or refinancing primary residences of up to four units and the minimum construction cost is, again, $5,000. Unlike the 203(k) program you can use it for some types of single-unit investment properties.
The deposit requirements depend on the kind of property; single unit owner-occupied have the lowest deposit requirements at five percent of the sale price if it is a fixed rate loan or ten percent for an ARM. The deposit requirements are higher for multi-unit properties, second homes, and investment purchases, or refinances. You should consider your options carefully and discuss them with an experienced lending professional before you commit to any of them.
The HomeStyle loan allows you to draw up to fifty percent of the appraised post-renovation value for costs of repair and construction. The improvements to the property must add value to it to qualify for inclusion in the loan.
The project must finish within six months, and you will have to make mortgage payments throughout the construction period. Like the 203(k) program the application process is extensive, you will need to hire a general contractor or other licensed professional to develop and submit your plans before you receive approval for the loan.
How To Withdraw Equity For Home Improvement
It may be that you are purchasing a property that needs renovation or perhaps you want to give your existing home a tune up. The cost of doing major renovations is likely to be too high for you to fund it out of pocket, so what do you do?
The obvious answer is to borrow the cash and let’s make the assumption here that you don’t have a family member who is willing to lend to you. The answer is to call on the financial services industry to give you what could amount to a sum that rises well into five figures.
Loan Or Line Of Credit
One of the priorities to consider will be the rate of interest at which you borrow so take advantage of secured lending because of the lower interest rate than that of credit cards or unsecured lines of credit. You will be applying to a bank or finance company for a second or junior loan secured against the property that you are renovating; these loans come in two main varieties: Home equity loans and lines of credit.
The home equity loan is a junior loan that dispenses a lump sum at the start of the term, which means of course that you will pay interest on the entire amount from beginning to end. The second option, the home equity loan (HELOC) allows you to draw funds against the line of credit as and when you need to use them to support the progress of your project.
A HELOC only requires that you pay interest on the portion of the line that you withdraw them, which saves cost for you on interest payments; it gives you the flexibility to use as much or little of the line of credit as you might choose. It is worth noting that this facility usually carries an adjustable rate of interest. However, you have the advantage of being able to draw the funds, repay the balance, and then advance cash again, as many times as you may require completing the project.
It Is All About The Numbers
Home equity loans command a higher rate of interest than HELOCs; you advance the full amount, and then you pay a fixed interest rate on the outstanding balance. If your renovation plan calls for an exceptionally high level of funding, other options such as cash-out refinancing or refinancing with an FHA 203(k) home loan might be preferable. These options are suitable for projects that require $100,000 or more.
Withdrawing the equity from your home or investment property is something to do only after careful consideration and only for purposes such as renovations that directly improve the value of the asset by at least the amount that you draw from it. Done correctly, borrowing against your property to improve it can be an excellent way to increase your equity, and therefore your wealth.
Mortgage Originators Initiate The Process
Your mortgage lender is part of an extensive and wealthy system of residential real estate finance. The person at the very knife-edge of the lending process is the loan originator, the loan officer or independent arranger who helps loan applicants fill out forms, gather documents and submit the loan application; they are there to help you. Applying for a home loan is uniquely stressful, and surprises can pop up, even after you begin making payments.
However, the mortgage originator is also responsible to the lender, and they have to balance the conflicting responsibilities of being the person in the middle. The range of organizations that offer residential mortgages to consumers is diverse; banks, credit unions, and finance companies to name just a few, but, the function of the loan officer who directly facilitates the process of setting up home loans is a constant.
Back Office Issues And Secondary Action
The first factor is that there are many regulations involved in mortgage lending, which includes requirements for loan originator licensing under the 2008 SAFE Act, a Federal statute that dictates that all originators must hold either Federal or state issued licenses. Also, the practices that work well in one instance tend to apply to the whole market; consumer behavior determines lending officer behavior to a large extent.
In all likelihood, the next thing that happens to your loan once you have begun the term, your lender will sell it on the secondary mortgage market. As a borrower in good standing, this means little to you directly. However, it sends the loan into a system that spreads the risk among many investors and gives liquidity back to the mortgage companies, so they can keep funding new loans.
Your loan officer or independent originator hands off the mortgage to the company that funds it, the funder may hold it and service it in-house or, when it is an FHA conforming loan, sell it to Fannie Mae or Freddie Mac to bundle into mortgage-backed securities (MBSs).
Mortgage companies routinely sell home loans on the secondary market for real estate loans. The transfer does not impact borrowers directly. However, the servicer will stake a fraction of a percent as a fee to send the payments to the MBS holders.
Sending Home Loans Down The Pipeline And Servicing Them
The organization that takes your payments and passes them to the MBSs is your mortgage servicer, which may be the same company that initially underwrote your loan, or it may not. Do not be surprised if, not long after you have bought a new home or refinanced, your lender sends you a formal letter of notification of a new servicer.
It is a common practice for lenders to sell to your loan on the secondary market. They may also introduce another financial company that will service your loan by taking your payments. As surprising as this is to unsuspecting consumers, you need not worry, it is all business as usual and part of the structure of the financial industry that forms the foundation of America’s dreams of homeownership.
When you finance the purchase of a home, in most cases, you will either have to make a sizable down payment or take out a private mortgage insurance policy (PMI). The choice is cut and dried for most borrowers.
But in some cases, if you want to have the most refined control over your costs, you may be able to find another alternative to PMI. If the numbers add up, you may be able to take out a piggyback loan to top up your deposit and save money over the life of the loan.
The Piggyback Loan
A second or junior loan is that because it takes a subordinate position in its claim on your assets, should you default on the payments. Your primary or first lender can claim your assets in foreclosure and sell them. Any amount that remains, after the recovered first loan, goes to repaying subordinated obligations, which means more risk and higher interest rates for junior loans.
In practice, a second often means a home equity line of credit (HELOC). PMI does not contribute to repayment, and you can potentially pay a second back more quickly, reducing the interest when otherwise you would still lack the equity to escape the need for a policy. A small second with a term of five years may be the right ticket. If your first loan is for thirty years, you may still have a high enough balance outstanding that you require PMI for more than five years.
Finding The Right Tools For Any Situation
Another instance that this strategy might be useful is when using a second mortgage will enable you to avoid a high-priced jumbo loan. If your loan would take you over the conforming limit, a jumbo loan will have a higher rate of interest and put additional requirements on your loan. One remedy would be to use a second loan to keep within conforming loan limits, saving money for you in the long-term.
The question is how to make up the equity in your home and having an adequate down payment rather than a loan that requires private mortgage insurance and the added cost. There are other options, for example, if you are a qualifying veteran, VA home loans have no requirements for insurance, regardless of the size of the deposit.
Weigh Your Options
Using second mortgages to save costs is just one of the many options you have in home finance. Connect with your lending professional to work out the numbers. Using a piggyback loan to circumvent the requirement for PMI is creative and proactive, it gives you an advantage as long as you first set it up in a viable plan and then you discipline yourself to stick to the plan.
Deciding to use a loan to avoid the obligation for PMI is a matter of determining the value of the trade-off regarding the risk. You might be able to reduce your payment obligation regarding the total payments. However, it is important to remember that you can always cancel your PMI but a second loan is an enduring commitment; you have to pay until the debt has been satisfied.
Bonds are just loans that are so big that the institutions that create them divide them into standardized securities and slice them up into affordable units. That is what Fannie Mae and Freddie Mac do with residential mortgages; they bundle home loans together so that many small streams of income become giant securitized cash flows, this is the mortgage-backed securities (MBS) market.
For government debt and corporate bonds, the units usually are $1,000 each. For more technical bonds like MBSs, the units usually sell for $25,000 each initially. Once on the market, they can trade at a discount or premium to face value, depending on market sentiment.
The Market For Mortgage Backed Securities
Mortgage-backed securities give investors income from a small share in a wide range of borrowers. The MBS market helps you buy your home because they bring institutional money into the residential lending market and create a cycle of lending and investing that helps everyone. For most conforming loans, Fannie Mae and Freddie Mac do the work of putting MBSs together.
You take out a home loan, and the bank or mortgage company that sold it to you goes to the market and sells your loan for cash; the money they gave to you they recuperate from the MBS markets. The market makers then collect these loans and add them to new MBSs, which they sell to investors. The lender still services your loan, but they pass on most of your payment to the market, which distributes it to the investors who hold the bonds.
There has been a lot of talk in the financial press in the last decade about the MBS market; most of the chatter has put these bonds in a very negative light. However, there was a good philosophical concept behind MBSs, one that reflects the values of this country and its market-based culture of self-help. It is true that as the lending market overheated that financial markets made the situation worse and then suffered a collapse in 2008. Sub-prime loans were misidentified as triple-A rated debt and collapsed overnight, taking the markets down with them.
3 Reasons Mortgage Backed Securities Mean Easier Lending
They keep the funds liquid – Real estate is an investment that makes it difficult to withdraw funds; you cannot just cash out part of the value the way that you might sell off stocks or withdraw funds from a savings account. By taking loans and bundling them into securities the cash comes from the size of the market makes the best use of cash.
They replenish your local lender – More people can own homes because of the liquidity mentioned above. The cycles of cash that flow from institutional investors replace the funds for finance companies and banks, which can then create more loans.
They help to preserve standards in lending – As long as the agencies create the bonds correctly, and the ratings represent the actual quality of the underlying home loans, MBSs are stable assets that deliver income to investors. Although lenders do not have to follow the FHA rules for conforming loans, access to the secondary markets makes the terms appealing as part of successful lending business models, giving lenders a stake in maintaining high standards.
What Are These Bonds And Why Should Home Buyers Care?
When you borrow from a bank or finance company to buy your home, the loan itself becomes a valuable asset for the holder. The value comes from your promise to pay the amount due each month, on time, every month. Given the time and effort that it took to approve you and the solid reputations of the institutions involved, it is very likely that your promise to repay your conforming loan will be a sound investment for the holders of such bonds.
Consumers want to purchase homes, but they seldom have the cash to do so without some assistance. Real estate ownership requires capital, which has to come from somewhere. It is also difficult to buy and sell homes, compared to other investments like stocks and bonds. These agency bonds make buying your home affordable by providing the liquidity that allows investors to inject capital into the market.
Liquidity For Mortgage Lending
If there were nothing like the real estate bond market investors would be in short supply, and lenders would charge much higher interest rates. Since it is the equity in the land and buildings that secure the lending, it is a relatively safe investment, and that was the attraction to pool loans together and sells them as agency bonds.
Bonds are high-value loans in which brokers sell shares. In return for holding a bond, you get a coupon, which is a periodic payment, usually semi-annually, and the repayment of the face value of the loan when it matures. However, no law says that this is the only structure; it is a matter of the market makers finding the bond structures that are most popular with investors and exploiting them for profit.
Agency Bonds From Fannie Mae Freddie Mac And Ginnie Mae
Entities such as FNMA (Fannie Mae), FHLMC (Freddie Mac), and GNMA (Ginnie Mae), are not part of the government, but they do receive sponsorship for the agency bonds they create. These instruments pool together home loans and sell the bonds to investors. These organizations were set up to purchase home loans and bundle them as investments, to sell to institutional investors such as investment banks, pension funds, insurance companies, sovereign wealth funds, and wealthy private investors.
Agency bonds generate the capital that funds your home loan. It is this form of institutional investing that enables you as a homeowner to purchase a home with financing at a low rate of interest and a low down payment. Ginnie only invests in loans that are backed by government guarantees. Fannie Mae and Freddie Mac will buy notes that conform to their standards but which do not have the same government backing. The government backing makes the Ginnie Mae bonds even safer investments than the others.