Hard money lenders have a bad reputation - and a lot of the time, it is for good reason! These lenders give the rest of us a bad name and can cost their clients tens of thousands of dollars in unnecessary expense on every flip!
We have put together a list of some of the most egregious things to watch out for when shopping for a lender on your next investment project (and maybe these are reasons you should fire your current lender!):
1. Collect money up front
Does your lender charge you money just so they can tell you if they want to lend to you? Watch out for lenders advertising great rates, but requiring an upfront fee before giving you a firm written commitment. Some unscrupulous people make their money on 'due diligence' fees for loans they never intend to underwrite. If your lender can't give you a specific term sheet or letter of intent after asking you a few questions and collecting a few pieces of information, they probably aren't serious about earning your business.
Even something as seemingly legitimate as collecting a processing or appraisal fee should happen after terms have been nailed down and agreed to by the borrower.
2. Thousands in made-up fees
While you're making sure you don't pay any upfront fees, make sure the fees you do pay are legitimate! All lenders have hard costs associated with closing loans, and those are often passed on to the borrower. Common costs include appraisal fees, underwriting costs, and loan document preparation and processing fees. Junk fees that we've seen other lenders charge their borrowers to puff up their bottom line include mailing fees, printing fees, approval fees, delivery fees, lending fees, application fees, reporting fees, filing fees, and even recording fees (your lender doesn't 'record' anything officially - that's the title company's job)!
Before you agree to anything, ask your lender for a breakdown of the fees at closing, and then do the math!
3. Their rate is too good to be true
One of the reasons that lenders charge crazy-high fees is to hide their real costs so they can advertise silly low rates that aren't so low once you calculate the total cost of the loan. For example, if you're shopping for a $100,000 loan and your lender hides $2,500 in fees on the final statement at closing, that's equivalent to paying an extra two-and-a-half points at closing!
If a lender advertises a rate that is slightly lower than the competition, it is probably worth your time to investigate further, ask about other fees, and then evaluate the total cost of the loan. One way that unsavory lenders also mask their high-cost of capital as a low-priced option is with the length of the term on the loan. Most hard money lenders have terms between six and 12 months, but some advertise rates that are significantly lower than anyone else in the industry, only to list a disclaimer in the small print that the rate is only good for a certain portion of the loan.
Here is a nightmare example:
We had a client come to us for a loan, and we quoted him a 10% interest rate. He shopped that around and got a 7% interest rate from another lender. We warned him that that rate seemed too good to be true because we have the lowest rates in Texas, but he went with it anyway. A few months later, he called and told us that the lender who did his loan at 7% interest didn't mention to him that the rate was only for the first 30 days of the loan, and then the rate jumped to 14%!
4. Rates changed at the finish line
Just as you want to make sure there aren't hidden fees or terms that increase your anticipated cost of capital, make sure the rate you are quoted is the rate you end up with!
By far, the most common complaint we hear about other lenders is that their rates or fees get jacked up at closing. I can't count the times that people have shown me term sheets on previous deals that didn't match the HUD statement. Lenders that do this figure that by the time you get to closing, you are so invested in the project that you won't walk away just because they put an extra point or two here or there on your loan.
Not only is this dishonest, but it practically ensures that lender will never get repeat business. You can protect yourself from this type of scam by reading reviews of the lender online and asking other investors to refer you to a lender they have had success with. Chances are, if a lender has treated their clients right, they will be happy to refer them to you.
As with any investment decision, it pays to do your homework. Choosing a lender is no different! Arm yourself with facts, get everything in writing, ask others in the industry, and most importantly,, ask your lender questions! A lender that won't take the time to answer all of your questions is not the lender for you. The more you understand the lender's processes at the beginning, the lower the chances are for disappointment and regret down the road.
Ask if your lender can provide references?
Do they have an office you can visit?
How long do their closings usually take?
How can you be assured your rate won't change?
What is their draw process? Etc., etc.
The more information you have, the better choice you can make with respect to the lender you work with, and the better the experience will be with that lender.