Hard money lending is like conventional lending in some ways. But it is vastly different in others. For example, have you ever heard of an exit strategy for borrowing? You would not need one to apply for a residential mortgage. But in hard money, exit strategies are non-negotiable.
An exit strategy is essentially a plan for repaying what you borrow. It is not necessary in a residential mortgage scenario because it is just understood that you will continue making monthly payments until the mortgage is paid off. Hard money loans are structured differently. And because they are, borrowers need to provide an exit strategy with their loan applications.
Interest Only Loans
While there are exceptions to the rule, most hard money loans are structured as interest only loans. That means monthly loan payments are limited only to interest. The principal is not paid until the loan’s maturity date. When that date comes, the borrower submits the final month’s interest payment along with the full principal amount.
Actium Partners, a Utah hard money provider based in Salt Lake City, explains that a typical loan has a term of 24 months or less. Based on a 24-month term, the first 23 payments would only cover interest. The final payment would cover the remaining balance.
In terms of how this relates to an exit strategy, Actium Partners wants to know how a borrower will make that final principal payment when due. As long as the plan is reasonable, approval shouldn’t be a problem. But if there is any question about the viability of the borrower’s exit strategy, approval may not be forthcoming.
Exit Strategy Examples
The next question is what constitutes a reasonable exit strategy. That depends on the loan in question. Hard money loans are offered for a number of different purposes. As such, different exit strategies apply. Here are just a few examples:
1. Conventional Financing
A common exit strategy for real estate investors is conventional financing. An investor would arrange a hard money loan to obtain a new property quickly and with as little hassle as possible. Then, during the loan term, he would arrange conventional financing to pay off the hard money loan.
2. Proceeds From a Sale
It is not unusual for investors to utilize hard money as bridge loans. An investor obtains a hard money loan to buy a new piece of property with plans to put another property from his portfolio on the market. When that property sells, the proceeds will go toward paying off the hard money loan.
3. Rental Income
In some cases, the monthly income a rental property generates is high enough to cover an investor’s expenses and pay his debt to the hard money lender. In such a scenario, the investor would save cash over the first 23 months of a 24-month loan, then pay his debt at maturity.
4. Business Line of Credit
Hard money loans are occasionally made to businesses in need of immediate financing while they arrange a business line of credit. Arranging business credit can be time consuming. Meanwhile, hard money can be arranged in days. The exit strategy in such a case would be relying on a future business credit line to make good on the hard money loan.
There are as many exit strategies as there are hard money borrowers. The particulars of a given exit strategy are not as important as the borrower convincing the lender that his strategy is reasonable and workable. Any lack of confidence in a borrower’s strategy makes a hard money loan too risky for the lender.
