How do I get a term sheet from a hard money lender?

Estimated reading time: 8 minutes.

Question:

How do I get a term sheet from a hard money lender?

Post outline:

• What is a term sheet?
• What information is covered in the term sheet?
• How do I request a term sheet?
• How do I compare term sheets?
• Conclusion

What is a term sheet?

A term sheet is a document a lender provides to you (the borrower) that outlines the terms of the loan.

A term sheet shows that the lender is serious about making the loan, and will often contain wording that demonstrates some level of commitment on behalf of the lender. Hard money lenders know to put a lot of focus on a deal once a term sheet is fully executed, or signed by all relevant parties (typically the lender and you, the borrower).

What information is covered in the term sheet?

Not all term sheets are the same, but invariably they contain the most crucial elements of a prospective loan. These are items such as; the borrower, the subject property address, the loan amount, the LTV (loan-to-value) restrictions, the interest rate, the origination points, and so on.

While the specifics may vary by lender, a term sheet seeks to display the most relevant numbers for a given loan.

Let’s dive a bit deeper and see which items you are most likely to find across term sheets.

1. Total loan amount

The loan amount is one of the more obviously important numbers for a given loan, but it is not necessarily static or unchanging throughout the loan application process. There are a couple of reasons for the dynamism of the loan amount, primarily the appraisal and the specific hard money lender’s underwriting guidelines.

How “set in stone” the loan amount is will be based on where in the loan underwriting process you are.

If you are early on in the loan underwriting process, prior to an appraisal for example, then the loan amount initially offered may not match the final loan amount. One reason for this is that the appraisal could come back with a different value than what was anticipated. If the value is far from what was anticipated, then an adjusted loan amount is nearly always the result.

Many term sheets therefore specify that the terms laid out are contingent upon certain items, e.g. the appraisal, underwriting, and final approval.

The total loan amount, if there is rehab financing provided as part of the loan, will be different than the closing loan amount. The reason for this is that the rehab portion of the financing will frequently be “held back”. 

A hard money lender might fund 80% of the purchase price and 100% of the rehab; the 80% of the purchase price would contribute towards the closing loan amount, and the 100% rehab financing would be “held back”.

2. % or $ as-is value/purchase price funded

Hard money lenders will often specify the % or % amount of the as-is value or purchase price that they will fund.

Oftentimes, hard money lenders will limit their % to the lesser of the two values. The reason is that if you are paying a premium for a property, so that the purchase price exceeds the as-is value, the lender is not also subject to that premium by way of an increased loan amount.

3. % or $ of rehab funded

Many hard money lenders will fund 100% of the rehab portion of a project, but as was alluded to in 1. Total loan amount, this is most often done on a reimbursement basis. 

In effect, this means that you will be responsible for “floating” the first construction draw. 

If you have an 80k rehab budget divided into 4 equally-sized draws (20k, 20k, 20k, 20k), then you would be responsible for that initial 20k outlay. Of course, when the final draw is reimbursed, you will have then gotten that 20k back and the complete 80k rehab will have been funded.

4. LTV

LTV, or loan-to-value, is the loan amount divided by the value of the property. Although this is often referred to as just one static value, the LTV changes as the value of the property changes.

If there is no rehab to be done on the subject property, then most lenders will use LTV to refer to the LTAIV, or loan-to-as-is-value. 

If there is rehab that needs to be done, and the property will have an ARV, or after-repair value, then most lenders will use LTV to refer to LTARV, or loan-to-after-repair-value.

5. Interest rate

Term sheets will invariably lay out the interest rate for the prospective loan. The interest rate is simply what you are paying to borrow the money.

On a hard money loan, it’s common to see interest rates ranging from the high single-digits to the low/mid double-digits.

This amount can sound expensive on its face, but real estate investors often justify the cost because the term length is often relatively short with a hard money loan.

6. Points

Term sheets will also lay out the points charged on a loan. Points are synonymous with “%”.

For example, if your loan amount is $300,000 and you are being charged “2 points”, you will be charged an origination fee of $6,000, or $300,000 * .02.

Points on a loan are frequently placed on the front-end, but sometimes hard money lenders offer to put a point or two on the back-end of the loan (the exit) as a concession to borrowers.

7. Other fees

Term sheets will specify other fees that are charged on a hard money loan, including underwriting, processing, application, appraisal, legal, and closing fees. These are frequently estimates, although a reputable hard money lender should have a good idea of what these costs are. Some hard money lenders charge relatively few pre-closing fees, and others charge quite a few.

8. Term length

The term length is the duration of the loan. For hard money loans, the term length is often around 12 months, and rarely exceeds 36 months.

9. Borrower’s cash to closing

Term sheets will commonly lay out an estimated amount for how much cash you will need to bring to closing. A simple way of thinking of this is:

Cash to close = all closing costs – closing loan

All closing costs would include items such as the purchase price of the property, the origination points, and any other fees associated with the loan.

The closing loan is the amount the lender will fund at closing. Again, this amount doesn’t include the amount of rehab financing that the hard money lender will provide.

The above items should give you a good idea of what to expect on a term sheet. Most term sheets will, at minimum, include the majority or all of the above items. 

How do I request a term sheet?

A term sheet can be requested from the hard money lender during the application process. For most lenders, term sheet issuance is a standard part of their operating procedure.

You can reach out to the hard money lender after you’ve filled out a preliminary application to ask about timing of term sheet issuance. Some hard money lenders may be willing to provide you with a term sheet early on in the application process, although this term sheet will often contain wording that indicates the numbers are preliminary and subject to further underwriting.

As was mentioned in the above information section, the further along you are in the loan application process, the more accurate the loan terms will be.

How do I compare term sheets?

Term sheets will generally convey much of the same information, and as such you can compare the most important loan data points across term sheets.

The items mentioned above in the information section provide a good starting point for this comparison.

It’s important to note that not all real estate investors have the same set of priorities in obtaining a loan. Some real estate investors may be focused on minimizing their cost of capital, while others may be looking to maximize leverage, and still others might set developing a relationship with a local, reliable lender as their highest priority. As such, it’s important to clarify what your goals are, and then compare term sheets on that basis.

If you are looking to minimize your cost of capital, you will want to take into consideration not just the interest rate and origination points, but also the term length and other fees associated with each loan option.

If you want to optimize leverage, you’ll want to compare the LTC/LTV options available, and be sure to understand what underwriting restrictions each lender has with regards to these key metrics.

If your highest priority is to cultivate a relationship with a reliable local lender, then you’ll want to speak with other real estate investors and real estate professionals in your area to see which lender or lenders they’ve had positive experiences with.

Conclusion

In sum, a term sheet is a document you can request or will get from your hard money lender that displays the most important loan data points. You may automatically receive a term sheet early on in the loan process from a hard money lender, or you can inquire about the timing/request one after you’ve engaged the lender.

Do you need financing for a current or upcoming real estate investment project?

If so, fill out our preliminary application at this link to get started.