Hard Money Construction Loan

A hard money construction loan is a financial agreement regarding a construction project that is so risky a bank will not consider funding it. Investors who back these lending agreements are willing to take high risks for high profit returns, so a hard money construction loan can typically be four or five points above a bank lending agreement in interest rate and also have the inclusion of four or five initial cost points. Since a single point is equivalent to one percent of a loan's value, these added costs can be quite pricey in a million dollar construction loan which is actually a very inexpensive project in today's dollars. Typically the lenders of these kinds of transactions base their willingness to lend for higher risk projects because of their own personal knowledge of the property under consideration. The willingness to lend the money is based in the knowledge of what the land or property is really worth and the investor will then agree to lend for about sixty to seventy percent of the property value. In most cases, a lender will require that the borrower put up the remaining amount of the lending agreement needed for the project, sometimes requiring it to be the borrower's own assets and sometimes allowing twenty percent of the remaining thirty percent to be a mezzanine loan. Even in this scenario, in most cases a lender wants to see at least ten percent of the borrower's money in the project.

The worth of the property in question and the carefulness of the provider of the hard money construction loan to only fund sixty to seventy percent of its worth gives some real security to the high risk investor. In addition, these types of lending agreements are short term, often lasting a year or less. For example, a developer finds out a beautiful farm near a city is about to go on the market. These five hundred acres would make beautiful home sites for custom homes costing over a million dollars each. The family who has owned the land for sixty years is asking ten thousand dollars per acre for this very prime land and will not sell in parcels but only in its entirety. An investor in the city is willing to craft a hard money construction loan to the developer for three and a half million dollars and five points. The five points amount to a cost of one hundred and seventy five thousand dollars just for the privilege of borrowing the high interest money.

This hard money construction loan is made because the developer knows that once the real estate goes on the market, another savvy developer will quickly devour it. So prime is this land that the developer will not even try and negotiate the price of the land downward. The investor has demanded that the developer put up ten percent of the lending agreement value and so after lengthy discussions with his wife, their house's equity, amounting to seven hundred thousand dollars is part of the collateral for the lending agreement. In addition, the developer must secure a mezzanine lending agreement, which is a supplementary loan for the remaining twenty percent. He places the holdings and assets of the development company in a lien position for the other million dollars needed. Once the purchase money is in place, the prime real estate holding is the developer's to create home sites worthy of million dollar residences. The hard money construction loan is only for one year and so the developer will also have to begin raising money for the raw land to be turned into residential acreage and putting together sources for a longer term lending agreement for at least the three and a half million plus interest.

"But God commendeth his love toward us in that, while we were yet sinners, Christ died for us." (Romans 5:8) This particular developer showed a lot of courage in putting his house and business where his dreams and vision took him, but this was the first large hard money construction loan deal that the man had put together and he failed to understand one paragraph in the very hastily drawn contract between himself and the lender. The crafty investor had entered exit fees in this hard money construction loan contract and the paralegal who just happened to be the developer's brother in law had looked over the contract and failed to spot its significance. Exit fees are often put into these kinds of contracts which call for more money to be paid to the lender when the loan is terminated. Whether the loan was paid early, on time or late, the exit fees apply. A two point exit fee cost the developer another seventy thousand dollars on top of all the other costs of the construction lending agreement.

Sometimes a lender is hard to find in the area where a borrower is looking to complete a project. In this case, a construction loan broker might have to be used to locate and negotiate with a lender located some distance from the potential project site. The fact that the lender is not located in the area could possibly make the loan more expensive. For larger and more expensive projects, lenders will be groups of private investors rather than a single person or they may be companies that have large mortgage funds already put together and ready to engage with a potential borrower. In any case, it is not unheard of for a hard money lending agreement to happen in days instead of weeks or months.

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