no doc hard money loans
The no doc hard money loans mortgage market has greatly expanded since the 2009 mortgage crisis with the passing of the Dodd-Frank Act. The reason for this expansion is primarily due to the strict regulation put on banks and lenders in the mortgage qualification process. The Dodd-Frank and Truth in Lending Act set forth Federal guidelines requiring mortgage originators, lenders, and mortgage brokers to evaluate the borrower’s ability to repay the loan on primary residences or face huge fines for noncompliance. Therefore, no doc hard money lenders only lend on business purpose or commercial loans in order to avoid the risk of the loan falling within Dodd–Frank, TILA, and HOEPA guidelines.
From inception, the hard money field has always been formally unregulated by state or federal laws, although some restrictions on interest rates (usury laws) by state governments restrict the rates of hard money such that operations in several states, including Tennessee and Arkansas, are virtually untenable for lending firms
A no doc hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by real property. They are typically issued by private investors or companies. Interest rates are typically higher than conventional commercial or residential property loans because of the higher risk and shorter duration of the loan. A no doc hard money loan is therefore a type of loan that is secured by real property. These loans are primarily used in real estate transactions, with the lender generally being individuals or small companies and almost never regulated banks.
Pros And Cons Of No Doc Hard Money Loans
Most no doc hard money loans are for only three to four months. They have very high-interest rates compared to a traditional thirty-year amortized mortgage, but they are utilized because they allow the borrower to purchase properties that normally could not be afforded or would require a longer contract negotiation.
For example, suppose a property that costs at least a million dollars and most people just do not have a million dollars in cash, and if they had to go through a traditional route of obtaining a long-term mortgage, it would take over a month to close escrow.
In no doc hard money loans, the deal is only possible because the auctioneers or sellers are in some kind of financial distress and the prospective buyer is able to close quickly on these deals with the financial support of the lender.
Being able to use no doc hard money loans allows the borrower to purchase a property and close the operation within ten to fifteen working days, whereas a traditional loan can sometimes take over thirty days.
Interest In No Doc Hard Money Loans
The interest rates on hard money loans are typically higher than the rates charged for traditional business loans. Rates could be as low as 6% and as high as 14% or more.
Despite this, such loan options are popular among real estate investors for their fast approvals, higher flexibility, less extensive documentation procedures, and because they are sometimes the only option for securing funds.
Costs Of No Doc Hard Money Loans
Typically, if you are brand-new in the real estate market, then you probably cannot get as much leverage as an experienced investor can, so you are looking at obtaining no doc hard money loans at 85% LTV or 90% LTV at the best.
What does that mean is that if your loan to value ratio is either 85% or 90%? For example, if you have a million-dollar property, then the maximum that someone will loan you is either 850 thousand for an eighty-five percent LTV or 900 thousand if it’s 90 percent LTV. The remaining money should be brought by the borrower as a down payment.
Now, what does it cost to get no doc hard money loans? Well, for a brand-new investor you are typically going to see rates at ten percent annualized and two points for the origination. That means for your $90,000 loan a ten percent of that nine hundred thousand is due every year and an annualized rate, so after holding that loan for a whole year you have paid ninety thousand dollars in interest payments.
Yes, that sounds like a very expensive deal and much worse than a traditional long term mortgage, but it is worth it for the investor who is going to make two hundred thousand dollars on the back end.
Origination Fees As A Cost Of The No Doc Hard Money Loans
What are origination fees? Origination fees are about 2% of the no doc hard money loans and are the fees that the hard money lender charges you to originate the loan. The origination here means to create the loan for you, so using “creation” as a synonym with “origination”.
The no doc hard money lenders have people working for them in the back-office underwriting the loan, salespeople who are creating the packages for the borrower, lawyers drafting a contract, and working with you to close on time. All these back-office services cost money and finally the borrower will be paying for them in a line item called “origination fees”.
Most of them are 2% for new investors so for on a $900,000 loan on a 1 million dollar property and 2% origination fees you will be paying $18,000 just to close on the loan.
But they do not charge you directly this 2% of origination fees. What they actually do is that they just give the borrower a smaller loan, so instead of giving the investor that $900,000 loan expected, they are going to give the borrower a loan for $882,000 (eight hundred eighty-two thousand dollars).
Usually, the consequence of this is that the borrower has to come up with more money to close on the property in the first place.
Difference With A Bridge Loan
Most no doc hard money loans are used for projects lasting from a few months to a few years. Hard money is similar to a bridge loan, which usually has similar criteria for lending as well as costs to the borrowers.
The primary difference between a no doc hard money loan and a bridge loan is that a bridge loan often refers to a commercial property or investment property that may be in transition and does not yet qualify for traditional financing, whereas hard money often refers to not only an asset-based loan with a high interest rate, but possibly a distressed financial situation, such as arrears on the existing mortgage, or where bankruptcy and foreclosure proceedings are occurring.
Down Payment Required
So when you come as an investor/borrower to a closing table, what kind of funds do they need you to have when working with no doc hard money loans?
Obviously, they want the borrower to have the 10 percent or 20 percent as the down payment for the property, but you also are required to possess enough liquid capital to pay for the origination fees.
Furthermore, you are required to possess enough working capital to pay for all other buyer-closing costs like notary fees and other miscellaneous items that they charge the borrower when closing the deal for the property. Many borrowers include these miscellaneous items inside the origination fees line item.
When you are considering to enter into no doc hard money loans, you also have to be careful if they have a prepayment penalty.
Sometimes they will charge you for a predetermined number of months of payment regardless if you close the no doc hard money loan through a complete payment in one or two months.
Therefore, so some investors or borrowers do something called “wholetailing” where they buy a property with a no doc hard money loan, and they put it back on the market without doing anything, and they sell it within a short period of time.
If you have a loan that has a four-month minimum that you have to pay those four months’ worth of interest payments no matter what, that is a contract clause of prepayment penalty.
Hence, just be careful when you are getting a loan of this type to ensure that there is no prepayment penalty within the terms defined by the lender, or if there is such a clause, that it does not affect you because you have planned to spend a long time working on that project, presumably, a construction or renovation project, anyway.
Thus, no doc hard money loans are typically for the real estate business and specifically for house flippers, people doing fix-and-flip.
Complete Business Case From The Investor Point Of View
No doc hard money loans can be understood much better if we describe a complete step-by step business process life cycle starting from a prospective investor or potential borrower who is interested in a real estate object that requires a lot of renovation or that can be rearranged completely during an auction. This is the typical profile of our readers, by the way.
What usually happens in the real estate business is that the investor desires to flip a house and earn money from that operation.
The investor finds a property at a $250 000 purchase price at an auction, and he needs to close very quickly on this house, otherwise, the auctioneer may close the deal with another buyer.
Unless this borrower has 250 000 cash in his pockets to put down, he will require another source of money and that is usually where hard money lenders step in and the entire no doc hard money loans business approach appears, in opposition with traditional long term loans.
Typically, hard money lenders can obtain money for these investors very fast. Sometimes it is five to ten days, the time period in which they can have the money in your pocket or better said, available for you.
If you have a relationship with these lenders, what you will normally have after your first project working together, they can close in three to even five days or give you a proof of funds for you to move forward with the seller or auctioneer.
You can really work with them to be your financial partner to make sure you grab the best hammer price at the auction, so they specialize in the speed of getting deals done fast.
Now, why are they called no doc hard money lenders? Where is “hard money” coming from? It is because their terms and conditions are quite higher than usual. It is hard money because it is a little bit expensive money, however, it gets the deal done for the borrower.
The borrower will not care much about the higher interest rates of no doc hard money loans, because the deal can be closed faster with the seller or auctioneer.
So for example on this 250 000 dollars house from our example, let’s say they do a hundred percent of the deal (100% LTV in our hypothesis, but more typical is to find an average of 70% LTV) to purchase the home.
Your plan, as an investor, is to perform the renovations of the house spending, let´s say, fifty thousand dollars ($50,000) in renovations and you will sell it for four hundred thousand dollars afterwards.
Therefore, you bought it through a no doc hard money loan for the aforementioned 250K, you are going to put 50 grand in ($50,000) and you are going to sell it completely refurbished for $350,000. This represents earnings for $50,000 on this transaction, before taxes.
Back to the example. So the property has a price of 250k. You will invest in the renovation for “flipping” purposes 50k from your own money or a line of credit from the lender that is another loan that is for construction purposes.
After the renovation, you sell it for 400 thousand dollars. Thus, if you invested 300k (250k of the price of the house and 50k in the renovation), you have earned 100k of profit.
However, of course, you have to pay the borrower, closing in that way the different positions that could exist in the mortgage loan in case that there is more than one creditor.
You pay the borrower the principal amount of the no doc hard money loan that is 250k and now you have to pay their fees.
You have already paid, in our example, three points upfront. Thus, you have already paid the 7 500 upfront.
Apart from the “points”, that is the interest percentage paid in advance, now you also have to pay the 11 percent interest annualized. As our flipping life-cycle was performed in six months (acquisition of the real estate object + asset renovation + sell of the asset) so that would be 5.5 percent on the base capital of 250 K, which is $13750.
You pay them $13750 and the obligation is concluded. The hard money lenders have their money back after six months and the investor had an EBT (earnings before taxes) of about 80K from this deal because the borrower/investor paid at the beginning 7 500 (the “points”). Later on, the investor paid 13,750 as the interest rate.
This is how a no doc hard money loan is closed. The investor now, has a relation established with the lender and would start another “flipping” project and partner again together. This time, the investor would request a higher LTV, surely moving from 70% to 80%.
Mortgage Loans In No Doc Hard Money Loans: Requirement of a First Position
The lender will normally provide the funds to the borrower with the condition that he takes the first position on the mortgage of the property.
There are exceptions to this situation that will be studied below. But in almost all cases, the condition of the no doc hard money loan is to take the first position in the mortgage loan.
I will explain to you now how positions work in mortgages derived from no doc hard money loans. For the mortgage creditor, the first position on the property means that in the capital stack, they get paid out first.
There can be more positions such as second and third position. These positions define the level of priority of the mortgage creditors.
What that means is that if the house or real estate object goes into foreclosure and gets sold, the first position person gets paid a hundred percent first.
Regarding the mortgage creditor’s second position, if there is leftover money, then gets paid some leftover, and then the third position continues according to the priorities in the capital stack.
As we go down in the capital stack, the price of money gets more and more expensive because the prospective creditor who will assume the second position is engaging on a much higher risk. A first position mortgage right now is like a 2,5% up to 3%.
For a second position they might charge you a four and a half percent up to 6% and then a third position can be easily more than 10%
For example, a no doc hard money lender, who can provide you with 250 grand ($ 250 000): they want a first position on the mortgage, meaning they essentially “own the house” (not legally, of course, as the “house” is the collateral of the mortgage and is still in the property of the debtor).
If the debtor does not pay them back they are just going to “take the house themselves”. The lender will legally repossess the real estate object due to nonpayment in a process that can be judicial or not.
For American flippers doing this process in the European Union, a trend growing since 2021, the only difference is that all foreclosures are strict foreclosures in the EU, all are judicial, so there is no repossession, and the borrower at fault is given a period of fifteen working days to pay or to oppose limited exceptions to the foreclosure. The process is done in a Civil court (like a divorce process) and the process is called “mortgage execution”.
So back to our case, the hard money lender wants to be in the first position. He would usually not take a second position in the mortgage loan because it is too risky.
If you take a second position as a lender, you are at the mercy of the first position lender. The first position usually has all the rules and rights to decide what to do so if they do not want to sell, they do not sell.
Likewise, if they want to hold on and do nothing, or just renovate or upgrade the house taking two years for that, they have pretty much all the decision-making on from that first position. In these cases, no doc hard money loans are like a traditional loan.
However, we will see below that some investment funds enter into these no doc hard money loans to take a second position
Difference Between A Bridge Loan and A No Doc Hard Money Loan
Investment Funds Take the Second Position In The No Doc Hard Money Loans
Some investment funds only enter in the second position of the mortgage loan lender stack.
They do this to buy out the first position afterwards. So what I mean by that is this: they will come in, and they will arrange a loan with the borrower of, for example, five hundred thousand dollars.
They buy out the first position lender for less money than these 500 k of our example. For example, they will buy out the lender for 300 k.
So that is one way that a lender can get into a deal even if there is already a first position on it. They will just buy out the first position and assume the first position themselves. I see this approach in the market and it is done normally by investment funds and not by private lenders.
Determination of The LTV Ratio
Because the primary basis for making a hard money loan is the liquidation value of the collateral backing the note, hard money lenders will always want to determine the LTV (loan to value) prior to making any extension of financing.
A hard money lender determines the value of the property through a BPO (broker price opinion) or an independent appraisal done by a licensed appraiser in the state in which the property is located.
The loan amount the hard money lender is able to lend is determined by the ratio of loan amount divided by the value of the property. This is known as the loan to value (LTV). Many hard money lenders will lend up to 65–75% of the current value of the property. There is no such thing as 100% LTV for this type of transactions. These loans are meant for investors and the lenders will always require a higher down payment.
Typical LTV Ratios In These Loans: 70%
A hundred percent loan-to-value ratio (expressed as 100% LTV) is a ratio which from the lender’s point of view is very risky and they do not exist in the market.
Why not 100% LTV? Because, what happens if this house drops its price? imagine that the entire stock market drops 20 percent overnight? The borrower, who did not invest any money in this 100% LTV example, would simply walk away from the deal. The lender, instead, they will have their rights in the collateral, but they may also have losses that are about twenty per cent or a bit more.
That is why you will not see in the market 100% LTVs. More common could be an 80% or even more frequently, a 70% LTV.
In this case, the lender will grant the funds to the borrower up to a 70% of the purchase price, assume fewer risks, while securing themselves the first position in the subsequent mortgage loan. The investor or borrower has to perform a down payment of 30% of the purchase price and will receive the funds to enable the purchase from the seller or auctioneer.
In this way, the lender ensures that the investor does not walk away from the property because he has a good 30% of his own money in the property.
Once the hard money lenders know you well because you have been working together in the past, they could be doing a 100 loan to value for arranging a no doc hard money loans.
However, in general, they are very cautious at the beginning because, despite the foreclosure rights, the lender will seize the property (“repo the house”), the house has to be put on sale and probably accept a loss.
The previous evaluation depends on the hard money lender you are working with. If you have worked in the past with the lender, he may take more risks and go with a 90% LTV for the following no doc hard money loans.
Fast Turnover and the Internal Rate Of Return In No Doc Hard Money Loans
For this topic, we continue with our example: The lender provided 250 thousand dollars to the investor while securing themselves a first position in the subsequent mortgage loan. The investor plans to invest in the home renovation about 50K, reselling it for 400K and obtaining a good revenue thereof.
Lenders of no doc hard money loans typically want the investor to complete this “flipping life cycle” short term. They do not want to engage in a contract for over a year because it hurts their returns, it hurts their IRR (Internal Rate of Return). The faster you receive back the money (velocity rate), the higher the IRR you obtain.
Some lenders will want a monthly payment while some lenders will say: “I want a balloon payment at the end of six months“, so six months and one day “I want my 250.000 of my loan back, plus my interest rate of 12 percent“.
The faster the turnover, the better for the no doc hard money lender.
Typical Contract Terms In No Doc Hard Money Loans
What are some typical contract terms that these no doc hard money loans have in common?
- The “points” (Modal average found in no doc hard money loans are three points)
A lot of no doc hard money lenders will propose this: they will require three points and 11% interest. Therefore, three points of 250k (3% points) would be seventy-five hundred dollars ($7500) they want upfront.
- Insurance and legal documents
You can negotiate with them who is going to pay for the title insurance, and which party will pay for the legal documents.
Sometimes that is inside of the terms of the contract. They will say that of the $7500 they will cover the legal documents, but you will cover the title or vice versa.
- Interest (average is 11%) of the no doc hard money loans
And then we have 11% interest and this value depends on the lender. Sometimes they request 11% with disregard of the full payment of the loan, whether it is in six months, or three months, or two months
More common is to define an 11% interest annualized.
If the investor has completed the flipping in only six months, that really means that the borrower is paying 5.5 % because it is an annualized number.
As we mentioned, these terms in no doc hard money loans depend on whom you are dealing with and whom you are talking to, or from a lender’s point of view how this lender wants to pitch the proposal of the deal.
For you, as an investor, you can simply find another no doc hard money lender if you find out that the lender imposes you a high-interest rate, a very low LTV rate (less than 70% LTV) or is imposing you to pay the administrative expenses of the arrangement of the loan.
Just ensure that the lender you choose can put the money in your pockets in no more than seven working days.