An appraisal is an important part of the process when getting a hard money loan. This evaluation of your property’s current market value is essential for both you, the borrower, and the lender. The appraisal provides a clear picture of the collateral (your property) that secures the loan.
Hard money lending is a form of asset-based financing in which the loan is secured by real estate. The appraisal establishes the loan-to-value (LTV) ratio, which helps determine the amount that the lender is willing to loan.
Unlike traditional bank financing, hard money lenders often have flexible policies that vary from one lender to another. Some lenders might only need a desktop appraisal, while others might require a full appraisal or none at all.
Keep reading to learn more about hard money loans and the hard money appraisal process.
Hard Money Loans and Appraisals
Hard money loans often involve a significant financial commitment for both lenders and borrowers. Appraisals are a crucial part of the process because they directly influence the amount of capital that can be safely borrowed against a property.
Why Hard Money Lenders Need Appraisals
Hard money lenders require appraisals to determine the current value of the real estate you are borrowing against. The appraisal is a risk management tool that shows what the property is worth, and ensures that the loan amount reflects the property’s true market value.
Appraisals protect the lender’s best interest by preventing over-leveraging, and they help to set loan terms that align with their loan-to-value (LTV) ratio.
Understanding Collateral Value and Loan Amounts
- Collateral:
- Your property’s worth is essential in securing the loan.
- An accurate appraisal provides a valuation that is used to set the terms of the loan.
- Loan-to-Value (LTV):
- The LTV ratio is calculated by dividing the loan amount by the appraised value.
- A lower LTV means less risk for the lender, which can result in less money for the borrower.
- A higher LTV places more risk on the lender by giving the borrower more money
Knowing a property’s value helps hard money lenders establish how much they are willing to lend.
The Parties Involved
Hard money loans are different from traditional loans in that the hard money lender is typically a party not associated with any government organization.
The Hard Money Lender
Hard money lenders are typically private individuals or companies specializing in asset-based loans, and their main concern is the value of the real estate acting as collateral.
They will have specific loan requirements and often follow specific guidelines based on their risk adversity. Due to the emphasis on asset value over creditworthiness, hard money lenders impose:
- Higher interest rates: To offset the risk associated with less consideration of your credit history.
- Shorter loan terms: Usually lasting a few years or even months.
The Borrower
As a borrower, your experience in real estate could influence your experience with the hard money process. Seasoned investors may be familiar with the demands of quick turnarounds, while novices might need guidance on the intricacies involved.
You must be prepared to:
- Facilitate and understand an accurate appraisal: This shows the value of your property, which will then determine the loan amount.
- Provide required documentation: Expect to present detailed financials, property plans, and a loan repayment strategy.
The Appraisal Process for Hard Money Loans
As mentioned prior, the appraisal helps the lender determine the loan-to-value ratio and the feasibility of your investment.
Most often, hard money is used in the real estate development/flipping industry. The type of appraisal needed for this scenario is different than a typical appraisal.
Traditional vs. After-Repair Value (ARV) Appraisals
Traditional Appraisals focus on the current market value of a property, utilizing recent comparable sales to assess its value. During the appraisal, a licensed appraiser evaluates the property in its current condition and provides an appraisal report.
After-Repair Value (ARV) Appraisals estimate the value of the property with the assumption that the renovations and repairs have been completed. ARV appraisals are typically used for houses that are under construction or mid-remodel. Oftentimes, house flippers will use hard money loans to get money to fund the remodel, then repay the loan when they sell the house.
Alternatives to Full Appraisals: CMAs and BPOs
Instead of a full appraisal, you might encounter methods that are less involved, such as comparative market analyses (CMAs) or broker price opinions (BPOs). Most of the time, the lender will require an actual appraisal, but in some cases where the loan to value is low, these might be acceptable.
- CMAs involve a more informal assessment, where real estate agents compare your property to similar, recently sold properties (comps) to estimate its value. This is usually done with a few clicks through the MLS or third-party software.
- BPOs are conducted by real estate brokers, offering an opinion on the property’s value based on its condition and the market. However, they are generally less detailed and less formal than a traditional appraisal.
When a Full Appraisal Might Be Required
There are scenarios where hard money lenders will insist on a full appraisal:
- High-Value Loans: The higher the loan amount, the more likely a lender will require a full appraisal to assess the investment risk accurately.
- Complex or Unique Properties: Properties with unusual features or those that do not have good comparables typically need a full appraisal to understand their true market value.
Finding a Qualified Hard Money Appraiser
Your choice of appraiser should be based on expertise and reputation. This is not a common type of appraisal, so appraisers who are used to doing appraisals for traditional loans may not know the nuances of a hard money appraisal.
Look for appraisers with a proven track record who are well-versed in the local real estate market. Researching and selecting an appraiser who values transparency in their process can serve to expedite the lending process and ensure that all parties are clear on the valuation criteria used.
Cost and Timeline for Hard Money Appraisals
Along with higher interest rates, ARV appraisals for hard money loans will typically cost more than traditional appraisals.
The timeline can also be crucial if you’re working within tight deadlines. Many hard money lenders pride themselves on flexibility, but even the most accommodating lender needs an accurate and timely appraisal.
You should expect the appraisal process to be completed within a week, but the time frame can vary based on the complexity of your property and the appraiser’s schedule.
