“The man who won’t loan money isn’t going to have many friends – or need them.”
“There are 350 varieties of shark, not counting loan and pool.”
“Sure, Homer, I can loan you the money. However, since you have no collateral, I’m gonna have to break your legs in advance.”
–Moe from The Simpsons
I recently had a reader ask me about investing in hard money loans versus buying rental properties. She was interested in pooling her money with a few other investors and acting as the bank to other home buyers and wanted to know what I thought about the idea.
As many of you know, I am a fan of investing in rental real estate. We invest in it ourselves, and it’s part of our retirement plan.
Once upon a time, I considered being the bank and lending money to others so that they could buy properties. There are some upsides to lending money, often called hard money lending (HML) or private money lending (PML):
- It’s backed by real collateral. You’re not just loaning money to a friend or family with hopes of someday getting it back. Instead, you’re lending it in association with a mortgage that is tied to an actual piece of real estate. If the person who borrows the money defaults on the loan, then you can foreclose and get the property.
- Better interest rates than CDs or most bonds. Borrowers use hard money lenders because they can’t get standard financing from banks or credit unions. The reason that they can’t is because either they don’t have the credit rating to do so or what they’re borrowing for falls outside of the risk parameters that the bank will lend for. In either case, since there’s a higher risk of the borrower not paying the money back, the lender gets to charge a higher interest rate to balance things out. More risk = higher interest rate.
- Fees and quick turnover. Most hard money loans come with an upfront fee – around 2% of the total loan – and are for the purposes of rehabbing a property or for a real estate flip. Ideally, the borrower borrows the money for six months, sells or refinances through a traditional lender, and the hard money lender gets the money back. Lather, rinse, repeat.
I even went so far as to talk to a mortgage broker about how we could get involved in private money lending. I figured I could use my good credit – an irony since I was in grad school and had only a trickle of income coming in from teaching Kaplan classes – to borrow money, which I’d then lend to real estate investors, and profit from the difference in interest rates and fees.
Then my wife finally decided to put her foot down.
Are you sure about this? What if the loan goes bad? How will you repay what you borrowed?
Oops. Darn reality coming in and messing up my dreams.
Eventually, we were in a position where we could start purchasing rental properties with cash. We had eliminated one of the problems with trying to be a hard money lender without the actual cash to lend.
Yet, we decided to purchase rental properties instead of lending money.