The Complete Guide to Hard Money Loans: Underwriting & Draw Schedules

To buy a run-down property, renovate it, and flip it for a profit, traditional banks are rarely an option. Banks require a property to be in habitable condition before they will release a mortgage. If a house is missing copper piping, has a damaged roof, or lacks a functional bathroom, a traditional lender will reject the loan.

Hard Money Loans are the primary tool used by real estate flippers and developers to finance these distressed acquisitions. Funded by private investment firms or individual capital groups, hard money focus lies in the hard asset (the real estate) rather than the borrower's personal income.

Hard Money vs. Conventional Finance

The core differences between conventional bank finance and private hard money are significant:

• Underwriting Criteria: Banks check your DTI, pay stubs, and tax returns. Hard money lenders check the property's After Repair Value (ARV) and your track record as a developer.
• Property Condition: Banks require the property to be in good shape. Hard money lenders expect it to be distressed and often require you to perform renovations.
• Funding Speed: Banks take 45 to 60 days. Hard money lenders can close in 7 to 10 days because they bypass federal consumer mortgage compliance processes.

Key Underwriting Metrics: LTC vs. LTV

Hard money lenders protect their capital by using two key percentages to calculate how much money they will lend you:

1. Loan-to-Cost (LTC)

The percentage of the total project costs (purchase price plus rehab budget) the lender will fund. For example, if a lender offers 85% LTC, you must pay the remaining 15% out of pocket as your cash skin-in-the-game.

2. Loan-to-Value (LTV)

The percentage of the property's current value or its After Repair Value (ARV) the lender will fund. Most hard money lenders cap their total exposure at 70% to 75% of the ARV. This ensures they have a 25%+ equity cushion in the property if you default and they are forced to foreclose.

Understanding Rehab Draw Schedules

When a hard money lender agrees to fund your $50,000 rehab budget, they do not hand you a check for $50,000 at closing. Doing so would expose them to the risk of you running off with the money.

Instead, the rehab budget is held in an escrow holdback account and released in stages using a Draw Schedule:

1. Self-Funding Phase: You pay your contractors out of pocket to complete the first phase of work (e.g., demolition and framing, costing $10,000).
2. Inspection Request: Once completed, you request a draw from the lender. The lender sends an inspector to verify that the framing is indeed complete.
3. Reimbursement Draw: If the inspector approves, the lender releases $10,000 from the escrow holdback to reimburse your bank account.
4. Cycle Repeats: You use that cash to fund phase two (plumbing and electrical), and repeat the inspection cycle.

Note: Each draw inspection typically costs between $150 to $250, which is deducted from the draw payout. You must plan your cash reserves accordingly to handle these lag periods.

The Cost of Hard Money: Points and Interest

Hard money is expensive. It is intended to be used for months, not decades.

• Points (Origination Fees): 1 point equals 1% of the loan amount. Lenders charge 1 to 3 points upfront at closing. On a $200,000 loan, 2 points equals a $4,000 fee.
• Interest Rates: Rates typically range from 8% to 15% per annum. Most hard money loans feature interest-only payments, keeping your monthly holding costs lower during construction.

A Mathematical Underwriting Example

Let’s calculate your starting cash requirements for a flip:

• Purchase Price: $100,000
• Rehab Budget: $50,000
• Projected ARV: $200,000
• Lender Terms: 90% Purchase Price Funding + 100% Rehab Funding; 2 Points origination; 10% Interest rate.

Let's calculate the loan structure:

• Purchase Loan Portion (90% of $100k): $90,000
• Rehab Loan Portion (100% of $50k): $50,000
• Total Gross Loan Amount: $140,000

Let's check the ARV safety limit:

LTV % = $140,000 / $200,000 (ARV) = 70.0% (Passes the 70-75% lender rule)

Let's calculate your cash required at closing:

• Down Payment (10% of purchase price): $10,000
• Origination points (2% of $140k loan): $2,800
• Lender admin & underwriting fees: $1,200
• Total Cash Required at Closing: $14,000

Crucial: On top of the $14,000 closing costs, you will need approximately $10,000 in personal cash reserves to fund your first rehab phase before you can request your first reimbursement draw.