Hard money lenders pride themselves on offering a combination of speed and a streamlined underwriting process. But to make everything work, borrowers need to submit some very specific information with their loan applications. In particular, they need to submit a reasonable exit plan.
If I were advising a first-time hard money borrower, I would suggest figuring out an exit before submitting an application. Why? Because a borrower’s exit planned could make or break loan approval.
Exit Plan Basics
Also known as an exit strategy, an exit plan is a plan for paying off the loan on its maturity date. A firm like Salt Lake City’s Actium Partners requires a solid exit strategy for one simple reason: their hard money and bridge loans are structured as interest-only loans. That means the borrower makes interest payments for the term and then makes a balloon payment that includes the principal at the loan’s maturity.
Imagine you are borrowing $500k on a hard money loan with a 12-month term. For the first 11 months, you will only pay interest. Your monthly payments will be affordable. But on the final payment date, you will owe the last interest payment plus the entire principle and any associated fees. Where are you going to come up with that kind of money?
Common Exit Strategies in Hard Money
When viewed through the lens of my hypothetical example, it should be clear why hard money lenders require a reasonable exit strategy. They need to be comfortable enough about a borrower’s ability to repay before they issue approval. If there is any concern that a borrower can’t repay, approval isn’t likely.
What constitutes a reasonable exit plan? That depends on the lender and its risk appetite. Here are the most common exit strategies in the industry:
Traditional Financing – The borrower obtains a traditional loan to refinance the property. Funding from the loan pays off the hard money lender.
SBA Loans – A hard money loan can act as a bridge loan while the borrower secures financing from the Small Business Administration (SBA). An SBA 504 loan is a great example because it offers favorable rates and terms.
Property Sale – Hard money loans utilized to purchase fix-and-flip properties are paid off when the property in question is sold. Similarly, an investor who leverages hard money as a bridge loan between two properties will pay off the hard money loan when the first property is sold.
Property Income – When hard money is used to acquire an income-generating property (like a multi-unit apartment complex) revenue generated by the property can be set aside and used to satisfy the loan at maturity.
Private Investment – Hard money loans are often sought because they can be arranged quickly. In some cases, borrowers arrange private investments after the fact. Investment funds repay the hard money lender.
Other Assets – In situations calling for borrowers to put up some other form of collateral, separate assets can be utilized to repay. The assets are sold prior to loan maturity.
It is up to lenders and borrowers to determine what constitutes a reasonable exit plan. Borrowers new to hard money may have fewer choices simply because they don’t have experience under their belts. More seasoned borrowers are often given more leeway in their exit plans.
Regardless, every borrower needs a workable and reasonable exit plan to get approval for a hard money loan. If you are new to this whole thing, research exit plans thoroughly. Make sure you have figured out your exit before you apply for a loan. Otherwise, you might not be approved.
