Funding a real estate property is a big and expensive endeavor. As a result, many investors often have to resort to a loan to finance their plans. However, where traditional mortgages are slow and require tedious checks, hard money loans are much faster and less concerned about your credit score.
Still, that doesn’t mean every borrower is equal and has access to the same funds. This raises the question of how private lenders determine hard money loan limits. Continue reading below as this article explores the factors that influence loan limits so you can be better prepared for your next application.
Primary Factors that Influence Loan Limits
Loan-to-Value Ratio
For starters, since private money lenders place less emphasis on your credit history, they operate a more collateral-based loan where they weigh the value of the property you want to purchase. This metric is called the Loan-to-Value (LTV), and represents the loan amount as a percentage of the property’s current “as-is” value.
For example, if a house is worth $250,000, and the lender offers the typical maximum of 70%, that means you can expect $175,000 at best. Lenders usually assess the debt-to-income ratio before approving your application, so that could factor into the lender’s cap ratio as well, because the lower the LTV, the less risk they have to take.
After Repair Value
Another factor that can influence your loan limit is the after-repair value. Unlike the LTV, which values the property’s current state, the ARV looks at its potential after all planned repairs and improvements are complete. As a result, this factor is particularly relevant for investors looking to flip a fixer-upper. That’s because lenders may offer you a loan based on a percentage of the ARV, typically using the “70% rule.” In other words, if a distressed property has an ARV of $200,000, a lender might offer a loan of up to 70% of that value, or $140,000. This loan amount would cover both the purchase price and a portion of the renovation costs, allowing investors with limited capital to fund their projects.
Property Type
Consider what type of property you’re trying to finance when asking for favorable terms from your lender. For instance, investors who deal with residential and single-family units are more likely to get better deals because these property types are easier to sell and are usually managed by a local property management company. In comparison, commercial properties such as office or rental spaces, and multi-family units have a different market. As a result, their ARV and LTV calculations also differ based on the jurisdiction.
Condition
Expect private lenders to be wary when you present a proposal for a property in extreme distress. Yes, lenders are more liberal with the type of real estate projects they fund, but there’s no denying that a house that needs more work requires more money for rehabilitation and renovation. As a result, any lender that chooses to finance your project would be taking a big risk, as you’d most likely need a higher LTV. Thus, since a property’s condition can tell you a lot about its viability, it directly impacts most lenders’ loan limits.
How Do Private Lenders Determine the Amount of Loan?
Investor Experience
Experienced investors with a proven track record of successful projects are more likely to secure higher loan amounts. Lenders see investors with experience as lower-risk borrowers who can manage renovations, budgets, and timelines effectively. On the other hand, first-time investors may face stricter limits or require additional documentation. For instance, if you have a track record of successful home flips worth $300,00%, getting 70% ARV on a house worth $400,000 would be a walk in the park. The same can’t be said for a newbie trying to flip their first house.
Exit Strategy
A well-defined exit plan can help improve your chances of a bigger hard money loan amount. Besides experience, a clear and realistic plan for how to sell, refinance, or generate rental income with the property can directly affect a private lender’s decision. Every lender wants assurance that the borrower has a solid plan to repay the loan, and the more feasible the exit, the more flexible the funding.
Conclusion
Understanding how private lenders set their hard loan limits can give you an edge in your next negotiations. For example, the loan-to-value ratio and after-repair value are metrics that tell you about what a property is worth and its potential. The property type and current condition also give more information, giving lenders a clearer picture of the project’s viability. Combined with details such as your experience and exit strategy, lenders can realistically predict the outcome of your investment before deciding to move forward. Knowing what they look for improves your chances of securing capital and the best loan terms.
