There are a few ways of borrowing money for acquiring real estate.
- Institutional -> "A" Lenders
- Non-Institutional -> "B" Lenders (not banks but almost)
- Private Lenders -> Individuals with money or access to low interest money (ex: borrow at 3% and lend it at 12%)
Typically when using a private lender you should expect for the interest rate to be higher. 7% up to 25% depending on the risk of the loan.
- 7% -> First position mortgage for someone who almost qualifies for a traditional mortgage
- 10% -> Second position mortgage set up behind a traditional mortgage
- 10-15% -> For individuals who do not qualify for a traditional mortgage (ex bad credit)
- 15-25% -> Bail foreclosure loan - High Risk (Most lenders offering these loans are not really expecting for the home owner to be able to keep up with this high interest loan. This loan is mostly used as an entry to acquire the property at a significant discount. It's really setting up the home owner for failure but I suppose getting foreclosed on is also a failure.)
So why would we use private money or hard money lenders if the interest rates are so much higher? Well, the bank have seriously narrowed who they will lend to. Making acquiring properties, mostly for real estate investing, more difficult. You may not be able to get a traditional mortgage if:
- Your credit score is less then 600
- Unable to prove income sufficient for loan (banks will only count 50% of rental revenue)
- High credit card debt (debt / service ratio)
In fact, it may be somewhat easy to acquire the first couple of rental properties, but for the next few, is almost guaranteed that it will have to be through private money. Keep in mind, a hard money loan should be considered as a temporary solution. In most cases the term will not be more then a year.
Taking aside the high cost of money with private money there are also very good features with borrowing privately.
- Criteria to get a loan are lower
- Lender is a person not an institution (terms or changes down the road will be more flexible)
- Commercial lending is simplified
- Loan will take in consideration the details and value of the property as oppose to your personal situation.
In larger commercial deals, it may be easier to get a mortgage from an "A" or "B" lender but chances are that they would only finance a relatively small portion of the value of the property. 50 to 60% for an "A" lender. In this situation, you can couple this mortgage with other form of lending. VTB or vendor take back, where the seller agrees to hold on to a portion of the mortgage (this will normally be from the equity in the property). And of course Hard Money lenders. In almost all of these circumstances, the lenders will require that a portion of the price of the property is covered by you directly, normally 5 to 10% of the purchase price. There are some ways to minimize if not eliminate that amount, but that will be for an other post.
Have you considered becoming a Hard Money Lender? Ask yourself this, are your investments providing at least 7% return and are they secured? The financial market have shown in the past 12 years 3 drops of 50%. That not only effects your return on your investment but it affects the principal of your investment. You come out of it with even less money then you went in with. It is very unlikely that you will lose your principal when investing in Hard Money loans. One of the disadvantages with becoming a hard money lender is that it is not truly a source of passive income. And you will only be bringing in money for the term of the loan, after which you would have to set up an other loan. But unlike having Buy/Rent/Hold properties, you are not affected by the tenants or vacancies when you are the hard money lender.
There are a few ways of becoming a hard money lender. You can develop your own relationship with real estate investors and provide them with a loan when they require it. You can still evaluate the deal and decide if you wish to invest of not. But with this method you may not get access to very many deals although you would form a good relationship of the investor and get a good sense of if they are good investors after some time. This would also be a great way to set up arms length mortgages with your RRSP.
You could join a mortgage investment corporation. This special form of corporation can lend money but the income and expenses is taxed with the lender. This will give you the advantage of having your money pooled in multiple mortgages as opposed to be tied up to just one mortgage. Keep in mind new legislation are coming into effect regulating these types of corporations. They will be less profitable in the upcoming future and be handled more like mutual funds.
You could also get in contact with a mortgage broker. In fact when selecting a mortgage broker from my power team, I always ask if they have access to private money. A mortgage broker will come across many investors and many lending opportunities. They would also take care of all the advertisement and screening for potential borrowers. Once you are presented with a real estate investment deal from a broker, be sure to do your own due diligence. Evaluate the deal, and verify the value of the property as oppose to the asking price. You would probably need to have over $300K in money available to loan for this option.
Well I hope this post as shed some light on hard money lending, and have made you more comfortable in using them or providing them.