If you are going to use a hard money loan on your property, you need an exit strategy. These loans, which are useful for entering the world of investment real estate, come with terms and conditions that can harm your profits. In the short term, they are fine. In the long term, they can be costly.
Fortunately, there are a variety of methods that you can use as a hard money exit strategy.
What is a Hard Money Loan?
Hard money loans are a form of short-term financing used to purchase investment property. These loans are structured in a vastly different format, and have different terms and conditions compared to a typical loan on an investment property.
Generally, they are structured as a loan with very short repayment schedules, sometimes six to eight-month terms. You read that correctly, instead of a 15-year or 30-year mortgage, these investment loans sometimes need to be repaid in roughly half a year! They often come with interest-only payments or accrue interest that is paid off when the property is sold.
The details vary, but overall they come with higher interest while allowing for purchases with lighter credit and income requirements. Some borrowers who may not qualify for a traditional mortgage (because of credit, for example), could qualify for a hard money loan.
Considered a means of last resort, these loans are primarily used to purchase real estate as an investment, often to purchase a “fix-and-flip” property.
One of the defining details of these loans is that they are not offered by banks, credit unions, and other “traditional” lending organizations. Instead, they are offered by companies, hedge funds, and even individual lenders who supply their own money.
Popular Hard Money Exit Strategies
Hard money loans are a useful and convenient way to enter the world of real estate investments. If you have few other options, they may allow you to purchase a home when you otherwise can’t.
However, they come with terms that can be more costly. Usually the interest rate is much higher than other loans. With high interest, these loans can chew into your profitability.
For this reason, wise investors have an exit strategy. Before taking out the loan, they have a clear idea of how they will pay off the loan.
1. DSCR Loans
A debt-service coverage ratio (DSCR) loan looks at the total cost of ownership, including the mortgage, taxes, and upkeep, and compares that number to the total income brought by the property. If there is a net gain from the property, you can likely use a DSCR loan.
These loans are useful when you don’t have typical income documents, and they are also a preferred method when you need to get rid of a hard money loan. The loans focus on reaching qualification, essentially, through your credit score and the cash flow coming from your rental property. Unless the property is already rented out, a rental survey usually needs to be completed by a qualified appraiser.
2. No-Ratio Loans
There are a variety of no-ratio loans, which are fairly self-descriptive. There is no required rental income to qualify, which means the market rent is not supporting the total cost of ownership. If you have a property that costs more than it brings in (which would mean a negative debt-service ratio), you won’t qualify for DSCR loans. In that situation, a no-ratio loan can be an extremely useful option for exiting a hard money loan.
In fact, if your rental property is bringing negative cash flow, it may be caused by the high cost of a hard money loan. In that case, this option could help turn the finances in the right direction.
3. Refinance to a “Typical” Investment Property
If your plan was not to flip the property, but to use it as a longterm rental, refinancing into a new loan may be the right choice. Refinancing with a traditional lender, such as a bank or credit union, can help you pay off the hard money loan and avoid paying massive sums toward interest.
Hard money loans are often used as a bridge between applying for and being approved for another loan. These loans are sometimes used by buyers who simply need time. They start with a hard money loan, then once the documents are in order, they replace the hard money loan with an investment loan from a bank or credit union.
4. Sell the Property
This may not seem like the best option if you are looking to build a large portfolio of properties that will bring longterm financial stability. However, selling a property and using the proceeds to pay off the hard money loan (while keeping some for yourself) could be the best option.
This is actually a common exit strategy for hard money loans. Many investors are not in a property for the long haul. Instead of holding the property, they make the purchase with a hard money loan, make improvements to the property, then sell for a profit. The proceeds can pay off the principal, the interest, and, if done with skill and patience, bring a small profit.
Best used by borrowers who have experience in the market and know which properties can be sold for a high price, selling the property can be a convenient and simple way to exit a property.
5. Use Business Capital or Personal Savings to Buy Yourself Out (Pay Off the Loan)
If you have the capital, it may be the best option to simply pay off the loan with your own cash. Although many investors don’t have the savings on hand (otherwise they may not be using a loan), this strategy can help reduce your total expenses and result in a more streamlined, secure portfolio of investments.
Depending on your situation, you may be able to use business capital to exit your hard money loan or you could use personal savings.
The Exit Strategy You Need is Waiting!
If you need to exit a hard money loan, contact our team today. We’ll provide the information you need so you can make a fully informed decision on your investments.
