How do I exit my hard money loan?

Estimated reading time: 6 minutes.

Post outline

1. Typical term lengths for a hard money loan
2. Prepayment penalties
3. Extension options
4. Two primary exit options: sell or refinance
5. Option 1: Sell the property
6. Option 2: Refinance the loan
7. Conclusion

Typical term lengths for a hard money loan

In discussing how to exit a hard money loan, it makes sense to first discuss the term length of the loan.

The term length is the length of time that it is possible to repay a loan whilst making regular loan payments. The term length is distinguishable from the amortization period in that it is generally a portion of the amortization.

While some hard money lenders do offer long-term products, most hard money lenders focus on short-term, bridge products, and therefore offer loans with shorter term lengths.

Most hard money loans have a term length somewhere between 9-36 months, and are “I/O” or “interest only” meaning that you only make monthly interest payments, as opposed to a fully amortizing loan where the monthly loan payments would go towards interest and also towards reducing the principal balance.

Some hard money lenders may offer term lengths slightly shorter or slightly longer than this, although generally term lengths shorter than 6 months or longer than 60 months are highly unusual.

Prepayment penalties

Prepayment penalties are common amongst hard money lenders. A prepayment penalty is a penalty that you, the borrower, get for paying off a loan early. The reason that prepayment penalties exist is because if you, the borrower, pay off early, then the lender receives less money than they originally anticipated throughout the term of the loan.

Sometimes, prepayment penalties are stated explicitly, and may take the form of a percentage point. Sometimes, a hard money lender might not have a prepayment penalty per se, but rather take a different approach and state a minimum for the amount of interest paid. 

Let’s demonstrate each through example.

Let’s say that a hard money lender has given you a loan with a term length of 12 months, and they have a prepayment penalty of “1 point” of the total loan amount if you pay the loan off at any point before the 12 months.

If you have a total loan amount of $300,000, and you refinance the loan in month 9, then you would pay a prepayment penalty of $3,000 for doing so.

Let’s say that a different hard money lender gives you a loan with a term length of 12 months, and doesn’t charge a prepayment penalty, but requires that you pay at least $5,000 in interest or borrowing cost.

Let’s say you received a $100,000 loan from this lender and are paying a 10% interest rate. In effect, you are paying $1,000 per month to borrow this money. Let’s say that you pay off the loan in month 3, after having only paid $3,000. You will then owe the difference between the $5,000 minimum and the $3,000 that you paid, or $2,000.

You will find some hard money lenders who have neither a prepayment penalty, nor a minimum payment.

Extension options

Sometimes, you may be approaching the end of your term length on a loan and realize that you need some additional time to either refinance your existing loan, or sell your investment property.

In this case, it is often wise to inquire about an extension from your hard money lender. Frequently, hard money lenders will charge a certain % of the total loan amount in order to extend the term length of the loan.

Let’s say that you have a $200,000 hard money loan with a 12 month term length. You are in month 11 and are lining up the refinance, but haven’t quite found another committed lender. You call your hard money lender and inquire about a loan extension. The hard money lender states that they charge a “1 point” extension for 3 months. In this case, you would pay an additional $2,000, or 1% of the total loan amount, to extend the term length of the loan.

As you can see, assessing the congruence between your project timeline and your loan term length can be an important skill with regards to reducing your cost of capital.

Two primary exit options: sell or refinance

When you are requesting a hard money loan, your exit from the financing will generally be to either sell the investment property, or refinance the hard money loan.

Borrowers primarily exit hard money loans by using the proceeds from the sale of the subject investment property to pay off the hard money loan, or by getting a new loan to replace the existing hard money loan (refinancing).

This distinction is important because it determines how you exit your hard money loan, and it also influences what factors the hard money lender will look most closely at when underwriting your loan.

If you plan to exit your hard money loan by selling your investment property, then your hard money lender is more likely to look at variables that affect your ability to sell the property at your desired price.

On the other hand, if you plan to exit your hard money loan by refinancing your hard money loan, then your hard money lender is more likely to look at variables that affect your ability to get a new loan.

Option 1: Sell the property

If you opt to sell your investment property, much like what happens in a fix and flip scenario, then the exit from your hard money loan will be to use a portion of the investment property sale proceeds to pay the loan off.

Let’s say that you have the following example:

Purchase price: $100,000

Rehab amount: $50,000

ARV: $225,000

Hard money loan amount: $120,000 (80% LTC)

Let’s say that you are able to sell the investment property for your ARV of $225,000. You would use $120,000 of those proceeds to pay off the hard money loan.

Option 2: Refinance the loan

Refinancing is the other way that real estate investors commonly exit from hard money loans. This is the exit with the “BRRRR” strategy that real estate investors frequently employ to receive cash-out proceeds and retain equity in their investment properties.

Let’s say that you have the following example:

Purchase price: $100,000

Rehab amount: $50,000

ARV: $225,000

Hard money loan amount: $120,000 (80% LTC)

Cash-out refinance loan amount: $157,500 (70% LTV)

In this example, $120,000 of the cash-out refinance amount would go towards replacing the hard money loan, and you would keep the remaining difference between the cash-out refinance loan amount and the initial hard money loan amount.

Conclusion:

Most hard money loans have a term length between 9-36 months. Some hard money loans have prepayment penalties, or a cost you incur for paying the loan off early. On the other side, some hard money loans have extension fees, or costs you incur for needing more time to pay off the loan.

There are two main ways that you can exit your hard money loan; selling your property and using a portion of the proceeds to pay off the loan, or refinancing into a new loan, and using the new loan to pay off the hard money loan.

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