More than one self-proclaimed real estate guru has attempted to convince consumers that it’s possible to invest in real estate without having any money. Often, these geniuses point to hard money lenders as a funding source, the implication being that such lenders don’t require down payments. Wrong.
The hard money lenders of three decades ago may have been just as reckless as retail banks, but that’s no longer the case. No hard money lender worth its reputation will provide 100% financing on a real estate deal. Hard money lenders require down payments and closing costs.
Table of Contents
● 100% Is Too Risky
The number one reason hard money lenders require down payments is simple to understand: providing 100% financing is too risky. Not only that, but it’s also too risky on multiple levels:
- Not requiring a down pavement mitigates any need for the borrower to act responsibly
- Recovering the entire amount borrowed in the event of default is much harder
- Fluctuating property values could put the lender underwater.
There are just too many downsides for hard money lenders to offer 100% financing. Likewise, there are no upsides. Lenders will not do it except in very rare cases.
● Down Payments Demonstrate Responsibility
Requiring a down payment is a means of forcing borrowers to prove they are responsible. An irresponsible borrower who doesn’t have any skin in the game has no incentive to make good on the loan. On the other hand, a sizable down payment demonstrates that a borrower is fully intent on honoring their half of the lending agreement.
● Down Payments Show Financial Strength
According to Salt Lake City-based Actium Partners, hard money lending is asset-based lending. That means lenders make their decisions based on assets offered as collateral. They do not look into credit histories, tax records, etc.
Not turning over every stone to investigate a borrower’s financial position limits a lender’s ability to understand the borrower’s financial strength. Down payments address that issue to some degree. A sizable down payment demonstrates financial strength. It can make it easier for a lender to give the green light to a deal.
● Down Payments Limit Foolish Deals
By their very nature, down payments limit the number of foolish deals investors get themselves into. It’s just common sense. If an investor is risking a significant amount of their own funds, they are going to be a lot more careful about what they put those funds into.
This benefits lenders in that they are not roped into foolish deals that only look good on paper. As long as the borrower is willing to risk a significant amount of cash, lenders can be more confident in the veracity of the deal. Both parties win.
● Down Payment Requirements Vary
One final note about down payment requirements: they vary from one lender to the next. Hard money lenders tend to follow the lead of their retail counterparts by utilizing loan-to-value (LTV) ratios to determine down payment.
A 50% LTV would require the borrower to cover the remaining 50% of the purchase via a down payment. Closing costs would probably be required in cash as well. However, some hard money lenders are willing to add closing costs to the loan.
The same general rules governing mortgages apply to hard money loans. For example, larger down payments lead to easier approval and better rates and terms. It’s always in the borrower’s best interests to bring the biggest possible down payment to the table.
Despite what you may have heard, down payments are still important to hard money lenders. They expect borrowers to contribute their own funds. They expect borrowers to share the risk. Without a down payment, neither is possible.