No one takes a hard money loan with a goal to default. In the ideal world, every fix-and-flip transaction would result in a profit for a rehabber and a performing loan for a private lender. At New Funding Resources, the majority of our borrowers never miss a payment, and less than 1% default on their hard money loan. We’d like to think that the thoroughness of our underwriting process has something to do with it. After all, we try to identify early on which transactions come with a too-thin of a margin and which borrowers are more likely to miss a payment on their hard money loan. That is not to say that problems do not arise from time to time. This is why borrowers need to know what it takes to stay current on their loan, what happens when the payment on your hard money loan is late, and how to avoid defaulting on your hard money loan.
Best ways to avoid being late on your hard money loan
Have sufficient reserves
Reserves are the money left on your account after you’ve made the contribution required by your lender. Adequate reserves are your safety net against unforeseen expenses. Even the savviest real estate investors can find themselves overextended. For example, your construction crew might discover an issue not covered by the original scope of work. Your contractor underpriced his bid or, worse yet, bailed out on you. Or you’ve planned to repay your loan in six months but your buyers are dragging their feet forcing you to keep your loan for longer than originally expected.
Who is financially responsible for meeting those additional expenses? You, of course. This is why it’s critical that you don’t stretch yourself to the limit. In other words, it’s not wise to invest your last dime into the transaction. To never be late on a hard money loan, make sure you have enough savings to carry you through rough patches that are bound to arise. Suggested reading: How to Succeed with Hard Money Loans.
Manage your rehab effeciently
Once your private loan closes, the real work begins. It’s now all about competent management of your rehab process. As a real estate investor, you now have two objectives. The first one is to ensure that your contractors deliver quality work while staying within the budget. The second objective is to speed things along as much as you can to reduce the carrying costs of your loan. People start missing payments on their hard money loans and fall behind because they fail to aggressively pursue both of these objectives.
For example, suppose your private loan is $200,000. Reducing the number of months your loan is outstanding from twelve to six would result in savings of $12,000. This is $12,000 in payments you don’t have to worry about being late on and, at the same time, an additional $12,000 in your own pocket. To see for yourself how reducing the time your private loan is outstanding minimizes your risk of default and increases your profits, play with our hard money calculator.
Stay on top of bookkeeping
Sometimes late payment on hard money loans happens because of a silly mistake. A borrower might simply forget to make a payment or send a payment to the wrong address. At New Funding Resources, we see each customer as a potential long-term partner to grow and build wealth together. This is why we invest resources in helping you manage all the obligations you have as a property owner. With us, you will get monthly loan payment reminders as well reminders to pay your property taxes and renew your property insurance. However, the best way to never miss a payment on your hard money loan is to set up an ACH payment. An ACH payment transfers the funds from one bank account to another without using paper checks, credit cards networks, or wire transfers.
What happens when payment on your hard money loan is late.
Though no one plans to be late, make sure you know how your lender handles late payments. This information is typically disclosed in the mortgage note signed at closing. However, don’t wait until then and don’t be caught unprepared: the best policy is to ask in advance.
A legitimate hard money lender typically provides borrowers with the period of time after payment is due but before late fees, interest, or other penalties start to accrue. It’s called the grace period. Suppose your lender’s grace period is ten days. Though your payment might be technically due on the 1st of the month, you will not be considered late or charged any late fees until the 11th of the month.
Your loan becomes officially “past due” once your grace period ends. At this point, you will start incurring late fees. The late fees differ from hard money lender to hard money lender but often fall between 10% and 15% of your regular monthly payment. If you are making a payment outside your grace period, call your lender to find what your late fee is and how they want to collect it. Typically, it would need to be included in your payment – otherwise, your loan might remain in the “past due” status.
Missing Payments Leading to Loan Default
A late payment to your hard money lender might be a temporary glitch in an otherwise healthy borrower-lender relationship. It also might be the first step towards a loan default.
Every lender has its own definition of loan default. However, the majority will consider a loan to be in default 45 days after the payment is due, especially if a borrower is not proactively communicating. A lender might also consider a loan to be in default if it has not been paid in full after it comes due. For example, if your hard money loan has a twelve-month term, it might be officially in default on the 13th month – even if you are current on the payments.
Loan Default Interest Rates
In case of default, hard money lenders can contractually charge the default interest rate. The default interest rate is significantly higher than the original rate of the loan. There are two reasons for the jump: to incentivize the borrower to keep his or her loan current and compensate the lender for the hassles of collecting on the defaulted loan. It’s important to remember that no reputable lender wants a loan to default. And no legitimate lender will pounce on your property for minor infractions. There are strategies how to extract yourself from the direst situations and I am about to share them with you.
Late Payments on Hard Money loans? Four moves to consider.
Communication is the key. You might be embarrassed or angry or prone to conflict avoidance, however being late on a private loan is the worst time to go incommunicado. The penalties for being late could be steep and by disappearing you practically guarantee they will be used against you.
If you are about to be late or encountered a situation that upends your investment plans, call your lender right away. At New Funding Resources, we’ve made notable exceptions to our loan default procedures to accommodate worthy borrowers. Sometimes bad things happen to good people and we understand it well. We are not here to penny-pinch anyone. In contrast, we pursue the long-term strategy of making money by being your partner and the preferred lender for the DC area – not by squeezing out the last dime from a borrower in distress.
Sometimes the borrower needs more time to finish the renovation than is allotted within the original loan term. Depending on the borrower and the transaction, a private lender might extend the term by a couple of months without charging the default rate. If this happens, you are in luck – you just got yourself a bit of extra room to breathe. However, such extensions are not always possible.
If you are late on your hard money loan (or the entire loan amount is due), one option for you is to refinance with another private lender. If refinance is possible, it can provide you not only with that extra time to complete the rehab but also with some additional funds you might need. Bear in mind, that not all borrowers qualify for refinancing. Private lenders are asset-based lenders and you need to have enough equity left in your project for a new lender to secure its lien against.
Sale of your project
In some extreme cases, the only option to salvage the project (and as much of your money as possible) is to sell it to another investor. It might not be the outcome you were hoping for, but it might be the most rational decision you make. Don’t let your pride or stubbornness hurt you financially. I have dealt with several borrowers who would have been better off by selling their project to the highest-paying buyer rather than wishing for miracles that never come.
Deed in Lieu of Foreclosure
In some rare cases, a hard money lender might agree to accept a deed in lieu of foreclosure, which avoids the foreclosure by transferring the ownership of the property to the lender. Not all private lenders are set up to offer a deed in lieu of foreclosure since it means they would be settled with the burdens of owning and rehabbing a property. However, when possible, it’s an effective mechanism to avoid a lengthy, costly, and stressful foreclosure process.
At New Funding Resources we work hand in hand with our borrowers to help them succeed. In real estate investing, success means one thing: the profit you’ve made is worth the time and the effort you’ve invested. Success is the result of many things. From the borrower’s perspective it requires good planning and effecient execution. From the lender’s perspective, success is based on wise underwriting that takes prudent risk. But it’s all in anchored by effective communication between all the parties involved. Our borrowers and us have the same goal: well-performing loans, honest profits, and long-term relationship with a honest and capable individuals. We are here to help you grow and prosper.