Vetting Hard Money Lenders: 5 Questions to Ask Before Signing

You have your eye on a hot piece of investment property. You have made an offer, and now you are working on arranging financing with a hard money lender. Before you sign any term sheet, make sure you know exactly what you are getting yourself into. Vet hard money lenders like you would any other service provider.

Actium Lending is known throughout Utah, Idaho, and Colorado for hard money and bridge loans investors rely on to acquire new properties. They recommend asking the following five questions before signing a term sheet:

1. Do you require an interest reserve?

While not all hard money lenders require an interest reserve, some do. An interest reserve is a certain amount of the loan’s interest paid upfront. Lenders sometimes require it to protect themselves on a risky loan.

The main issue for investors is having the interest reserve deducted from the proceeds of the loan at closing. An investor walks away from closing with less cash in hand. Why does it matter? Because investors need to know for sure how much cash they will have to work with . And the amount held back could significantly alter an investor’s budget.

2. What is your draw schedule?

If a hard money loan is going to cover both acquisition and renovation costs, an investor really needs to know about the lender’s draw schedule. It’s not unusual for lenders to release money in stages, as certain milestones are reached. The problem is that properties need to be inspected prior to each draw.

If it takes 10 days or more for an inspector to arrive on-site, an investor risks not being able to pay contractors and suppliers. The entire project could grind to a halt while he waits for the next draw.

3. Is there a prepayment penalty attached to the loan?

Being able to pay a hard money loan off early is advantageous for obvious reasons. Hopefully, there is no prepayment penalty attached. But if there is an investor needs to know about it upfront. Also note that some lenders attach minimum interest periods to their loans in lieu of a prepayment penalty. It’s pretty much the same thing.

A minimum interest period represents the minimum amount of interest the investor needs to pay, regardless of when he actually repays the loan. Let’s say it is six months. Even if the investor generates enough income from the new property to pay off his loan at the 3-month mark, he is still required to pay 6 months’ interest.

4. What value is the loan offer based on?

Hard money lenders can vary quite a bit in terms of how their loans are structured. Therefore, investors need to know what a particular lender’s offer is based on. Is the lender looking at the current value of the property as-is? If not, perhaps the lender is looking at the property’s potential value down the road. Here’s why it matters: whatever value the lender bases its offer on impacts how much money the investor has to bring to the table with a down payment.

5. Can I extend the loan if necessary?

While extending the terms of a hard money loan is not ideal, sometimes it is necessary. An investor needs to know whether an extension is even possible. And if it is, will the lender charge an extension fee? Both the lender and the investor need to be on the same page here.

There is a hard money lender for just about every deal. But not all lenders do things the same way. That’s why vetting them is so important before signing a term sheet.