How to Start a Hard Money Lending Business
Hard money lending is a topic that’s on a lot of lips these days and rightfully so.
In today’s economic climate, people need quick ways to access cash and don’t always have the time or credit to seek loans through a traditional bank. More and more, people are accessing funds through private lenders. That means a growing demand for the people who connect the investors with the consumers. Enter the hard money lending business. Hard money lenders secure funding from companies and individuals who want to invest. Then, they match those up with borrowers who are looking to fund their projects. If you’re interested in learning how to start a hard money lending business, you’re in the right place. This article will cover the basics of hard money lending, the pros and cons of becoming a hard money lender, and steps you can take to start your own hard money lending business.
By the end, you should have a good idea of whether or not hard money lending is right for you. We’ll also take a look at some of the most common questions people have when they’re interested in hard money lending.
What is Hard Money?
Depending on what part of the financial sector you’re in, hard money is defined in different ways. So as not to be confusing, we’ll use the definition that fits with hard money lending. That is, hard money is money that is secured by a physical asset’s value. That asset could be real estate property, heavy equipment, vehicles, and inventory. A loan is made based on the assessed value of that asset and the borrower usually receives a percentage of that value in a lump sum. The asset then becomes collateral for the loan. So, if the borrower is unable to satisfy the loan terms, the lender can take possession of the building, vehicle, or equipment that was valued to recoup their costs.
Hard money loans are attractive to borrowers because they’re often easier to get. Because the funds are secured by physical property, borrowers don’t have to worry as much about having a negative credit history. Hard money loans are often a fast solution to immediate cash needs. Private lenders don’t have to operate under the same restrictions as traditional banks do. So, they don’t usually require as much documentation and paperwork, shortening the application approval process. Hard money loans are also a great stop-gap for borrowers who are awaiting other, longer-term loans to come through.
Borrowers who seek hard money loans so they can fix and flip real estate property are a boon for hard money lenders. Since residential real estate properties are flying off the market faster than they have in the past – down to 36 days on the market from 44 the previous year – buyers can’t afford to sit around waiting. Competition for new homes on the market is fierce. So, it’s beneficial for them to be able to access fast cash when they need it to get a hold of that property before someone else does. Hard money loans give them what they need when they need it. Since they’re not staying with the property long term, they can repay the loan in the shorter term typical of a hard money loan.
As an investor, hard money loans are a good financial proposition. Realizing a return on investments is not dependent upon the creditworthiness of the borrower. In some cases, it’s preferable to have the borrower default on the loan and collect the property because the investor may realize higher returns. That’s not to say that investors encourage or desire failure on the loan, but this security makes hard money investing less risky and therefore more attractive. Because hard money loans typically carry a shorter term than traditional loans, investors see their returns faster.
Where hard money lenders come into the picture is connecting people who need money with the people who have it. It’s not easy for a borrower to find someone with the capital to lend them. They can’t just walk into a corporation or a wealthy individual’s home with their hand out. It takes time to build relationships with lenders who want to invest their money. The average buyer not only lacks the skills or access to these investors but usually has no reason to develop these relationships for a one-time transaction.
Hard money investors often either don’t have or don’t want to expend the resources to vet every possible borrower. They would need to not only invest their funds, but also invest in marketing, assessments, valuations, application processing, and financial verifications. It’s like starting a whole new business just to take care of the lending piece. A lot of these investors are interested in making money but don’t care to spend resources dedicated to lending. Their primary interests lie in the business they earned their money from in the first place.
This is where the need for an intermediary arises. This is where you, as a hard money lender, would step into the picture. You help investors more easily find borrowers and borrowers more likely to find investors. On the investing side, you handle identifying potential opportunities, filing paperwork, investigating assets, and vetting borrowers. On the borrowing side, you provide access to funds that would otherwise be inaccessible. You provide a central contact place for multiple funding sources and offer advice on how to best manage the loan.
That’s the big picture of hard money lending and what a hard money lending company does. There’s a lot more to explore. If becoming a hard money lender still intrigues you, read on to get more in-depth on the advantages and disadvantages of hard money lending.
Hard Money Pros and Cons
One very attractive feature of becoming a hard money lender is that you can make a living investing someone else’s money. That’s not to say that it doesn’t take any investment of your own capital to start a lending business, but most of your income will come from using investors to generate business. This means you can get into real estate and financial sectors without needing to have accumulated a tremendous amount of wealth yourself.
Since you are essentially a broker between the investors and the borrowers, you get paid upfront. You’re not usually the one investing in the loan. So, you have less risk than the lender does. If a deal goes bad, it’s your reputation on the line, but not necessarily your finances. You’re not responsible for paying the loan back to the lender.
Another advantage of getting into this business is that hard money lenders aren’t subject to the same set of rules and restrictions that banks are. Generally, that means you don’t have as much red tape to cut through and can negotiate more flexible loan terms. Hard money loans are usually processed and approved in a month or so. Shorter processing times can mean doing more business faster and making more connections.
You don’t have to be involved with real estate to be a hard money lender either. Hard money loans can be based on other assets like machinery, inventory, vehicles, and even shares in a company. This gives you a chance to diversify your business so that if the housing market takes a downturn, you aren’t reliant on it to bring in funding.
Hard money loan brokers generally operate on the local level. Having relationships with investors and knowing the local housing markets are both very important to the success of the business. With a startup staff, it can be difficult to build these relationships nationwide or to accurately read the ups and downs of the market. While this can be a very positive thing, it also means there’s more riding on local reputation.
Let’s be realistic. It’s not easy to be a startup company. Even though you don’t have to have an advanced degree or a banking background to start a hard money lending business, you do have to have a strong knowledge of financing and operations. Many of the qualities you need to be a hard money lender are the same as what you need to succeed in other startup businesses: hard work, networking, dedication, and planning.
A few startup numbers: According to the U.S. Bureau of Labor Statistics, about 20% of new businesses fail in their first year. After five years, that survival rate goes up to 50%. That means that only half of the businesses that started five years ago are still operating this year. At ten years, the percentage has fallen to 30% or roughly a third of all startups. Those numbers encompass all of the country’s startups, regardless of the type of business. The biggest growing business right now is healthcare. Transportation and construction, however, aren’t looking so good. What’s the most common reason startups fail? Failing to meet customer needs. That’s not startling, considering you already know you need customers to succeed.
Don’t expect to open your doors and immediately be flooded with borrowers. Both investors and borrowers care about their money. They want to trust the company they’re doing business with. So much of this business is done by word of mouth and referrals that you need to maintain important connections. Once you have an established reputation, things should get easier, but it can be hard starting as an unknown.
Hard money lending is regulated at the state level. To operate legally, you’ll have to know what your state’s rules are and abide by them. Should you decide to relocate, you’ll have to understand and satisfy a new set of rules. If your business is located near a state line, you’ll probably want to do business in both states. In that case, you’ll have to satisfy two sets of rules at the same time.
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Starting A Hard Money Loan Business
If you’re not discouraged by the statistics and are the kind of person who enjoys a challenge, getting into the hard money loan business could be a good choice for you. For someone good at networking, already has a strong connection with real estate, and understands what borrowers and investors are looking for, hard money loans can make you some money. The good news is that people always need money and people always want to make more of it.
Here are a few steps to help you get started in the hard money lending business.
Step 1: Establish yourself officially as a business. That means going through the process of incorporating or becoming an LLC. You’ll have to register your business and apply for a tax identification number from the IRS. You might also need one from the state or states you plan to work in.
Step 2: Obtain the right licenses and permits. The fastest way to get your business shut down is to fail to get the right permissions. Make sure you’re transparent about them once you do have them. This will lend your business some credibility and legitimacy.
Step 3: Establish a business account and keep your personal finances separate. It’s easy to get in hot water when you don’t make a clear separation between what you own and what the business owns. Having a dedicated bank account for your business makes that a thousand times easier.
Step 4: Get insurance to protect the business. In some cases, insuring your company is a requirement of maintaining your license. You also want to have protections in place to cushion you from the unexpected. If you’re operating out of a brick and mortar office, you need to have the building insured as well.
Step 5: Contact an attorney. Even if you’re an investment genius, you might not be a litigation expert. There’s a reason that attorneys have to go through rigorous education and exams. The law is a full-time pursuit that takes special training to fully understand. Hiring someone to make sure you have your legal ducks in a row is highly advisable.
After that, some good thing to keep in mind are:
Word of mouth is the best way to build a business. This means you need to treat people fairly and burn as few bridges as possible. If you haven’t already established a network with lenders and other brokers, there are business groups you can join that not only boost your numbers but give you a chance to meet others in the industry for advice and referrals.
Find a niche to operate in or, rather, a focus. Diversification is indeed important, but you can’t market to everyone all the time. If you specialize in securing funding for minority-owned small businesses or real estate loans for non-profits, focus on becoming the best in that niche. This way you can hone in on the needs of that specific group and how you can meet them better than anyone else.
Make referrals to other brokers. It might seem like this is giving business away, but it’s quite the contrary. As mentioned above, you can’t fill every niche yourself. Other brokers might be better at something than you are. Sending customers that fit their business over to them encourages them to return the favor and you’re still helping your customer. Both are solid reputation builders.
Be as transparent as possible. Integrity is essential in the hard money business. Don’t pretend to have experience or resources that you don’t or make claims you can’t back up. You want a reputation as trustworthy and dependable, not as a scam.
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Hard Money FAQs
There are some common concerns for those looking to get into the hard money lending business. After all, you want to be armed with as much info as you can get to succeed, right? Below are some frequently asked questions concerning starting your own hard money lending business.
Q. Do I need my own money?
The answer is yes and no. You could start with a hard money loan yourself or find an investor to give you the funds upfront. For the licensing, permits, and insurance, you may have to initially invest your own capital.
Q. Do I need a degree?
Unless your state requires it, you don’t necessarily need an advanced degree, but it helps. You can also start as an intern to learn about the business that way. Strictly speaking, you can have the knowledge you need without the degree. It does affect the perception of your qualifications, however. If you can show that you know your stuff, that’s sometimes all you need.
Q. How do hard money lenders make money?
According to the job search site, Simply Hired, the average loan broker’s salary is $83,686 per year. The highest salary measured in their survey was $195,496. So, how do they do it? Lenders make money on commissions paid by the investors, fees paid by the borrowers, or both.
Q. How is a hard money lender different from a bank?
Banks have to operate under very strict conditions to be compliant with federal laws. That makes the application process more restrictive and the loan terms less flexible. Bank loans generally have lower interest rates, but longer repayment periods. Their lending criteria are based on the borrower’s creditworthiness and the loans are long term.
Q. What gives one hard money lender an edge over another hard money lender?
There is certainly competition in the hard money lending game. The more successful lenders will have better customer service, be able to lend money faster, and have lower interest rates than their counterparts.
Q. What is the average interest rate for a hard money loan?
There is no national standard interest rate for hard money loans. They vary by region and lender, but they’re typically between 7% and 15% of the principal.
Q. What are points on a loan?
Points are a way for borrowers to pay lenders for a lower interest rate. Borrowers can pay a certain amount of interest upfront for a point. Each point they buy lowers the interest rate by a percentage.
The hard money lending business isn’t always easy, but it can come with great rewards. Following the guidelines in this article should give you a good start on understanding the business and starting your own. Remember that trust and transparency are important for your professional reputation and that most deals are done from that reputation. So, keeping up compliance with government regulations, being open about your rates and procedures, and responding to customer demands appropriately are essential to your success. There will always be someone who’s been in the business longer. Don’t be too proud to ask for advice and mentorship from them.
With hard work, dedication, and a little luck, you’ll be brokering hard money loans with ease and realizing great returns on your new business.
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