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The hidden costs of hard money

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Private money loans are notorious for having hidden costs.  This is not because the hard – or private money lender deliberately tries to hide those costs. It is more often because few individuals are aware of the range of fees that are involved in the hard money or private loan process.

Here’s a rundown of these hidden costs so that you know what the process involves and can consider them when you develop your budget and see whether you actually want to enter into a hard money loan transaction.

Upfront costs.

These fees are going to be more open. The hard money lender makes his profit this way. These fees are usually spelt in the promissory note or should be covered with you ahead of time. They are:

Points— Essentially, compensation to the private money lender for originating the loan. Points refer to a 1% of the loan balance given you so if you receive $1000, you’ll be charged $100. Some lenders share these points with person who referred you (known as referral fee). Others may add your points to the private investor who also invests in your funds. In this case, your bill may look like this:

-$8,000 to the hard money lender

-$3,000 to the referring hard money broker

-$4,000 to the private investor to increase his or her yield

Referral Fee – Sometimes covered within the points, but used to compensate others who may have referred you to the lender. Underwriting, Processing, Document Preparation or Other Fees – Paid to the private investors, the lender who originates the private money loans, or to outside third parties to create the loan.
In private money transactions, the loan documents are more unique that in a bank transaction which is why you should expect these costs to be a bit higher than traditional bank loan costs. Some hard money lenders waive the underwriting fee and replace it with points. Others add. Those are the upfront costs. Expect interim costs too.

Provisional Costs

You’ll have costs to pay throughout the process. These include:
Interest – Paid to the private investor on the loan at a prescribed rate for the use of the money.
Amortization – The repayment schedule of principal over the term of private money loans, if any.

Balloon payment – This is the huge final payment that the borrower makes to lender at the end of the term. Borrower typically pays a maximum of two prepayments followed by an initially agreed upon monthly payment. The whole is climaxed by this balloon payment. The lender will have the right to foreclose if you cannot make that balloon payment when agreed.

Taxes and Insurance – Sometimes paid into an impound account, sometimes paid by you directly.

Possible costs

These fees you can avoid if you want:

Late Fees – Penalty incurred if there is a late payment.
Advances – When private money loans are delinquent, the lender may advance against the loan for appraisals, unpaid taxes, foreclosure fees or legal fees.
Renewal fee – If you want an extension on your payment time or want to process another loan, your investor may allow you to renew the loan.  The renewal will typically require additional up front points and closing costs to generate the loan renewal documents.

Renewal fees are also paid when the borrower wants an extension on his loan. If you and the lender buddy up to one another, you may be able to negotiate better terms for yourself and, best of all, waive one or two costs.

Some other terms that you may want to know

You’ll bump into these terms during the process. Here’s what they mean:

Maturity Date – The maturity date is the date your loan is due and payable.  If you get a short term bridge loan, your maturity date may be in as little as 6 months or a year from now.

Amortization – Amortization is an accounting term that refers to the process of allocating the cost of the loan over a period of time. Many private money loans will typically be interest only because they are for a shorter duration than bank loans. Your lender will set up an Amortization Schedule which a table is showing the breakdown of amortized loan payments into principal and interest portions as well as the remaining loan balance after each payment.

Non-Recourse Loan – A loan in which the lender is not entitled to pursue the borrower’s other assets owned if the debt is not fully satisfied by the collateral in the event of foreclosure and resale of the property.

Secured Loan – A secured loan is one in which the borrower offers up something of value as collateral for the loan.   In a private money lending context, the security is real estate.

Acceleration Clause – A clause in a mortgage or deed of trust that advances the due date of the debt.  These are frequently found in private money commercial loans.

The short of it is this…

Each hard money lender has his particular terms and hidden costs. Terms range from two to ten years or more and loan amounts can vary from 20,000 upwards.  Borrowers should be sure to carefully review the lender’s interest rate, prepayment penalty, loan to value, default rates, APR, work out solutions, points (fees for the loan), etc. For example, a private individual may offer a lower interest rate than a hard money lending company, but may be unwilling to offer a work out plan, in the event the loan becomes delinquent, or a hard money lending company may offer a lower interest rate, but demand a high pre-payment penalty fee, costing the borrower more money if they decide to sell or refinance the loan within one to five years. Because these terms are not standardized across the industry, it is important to check with each lender and ask them for their “terms”, as well as any other additional costs.

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