Much like any business enterprise, a borrower must have an exit plan for paying off his or her hard money loan. This plan, called an exit strategy, can consist of many different potential scenarios including an intention to sell the property, refinance the loan to pay off the trust deed investor, or to have made large enough monthly payments to self-amortize and completely pay off the principal and interest by the loan maturity.
Exit Strategy 1: Sell the Property
As property values rise, property improvements are completed, or certain properties become perceived as more valuable, the opportunity arises for the trust deed borrower to sell his or her property. Once the property is sold, he or she can pay off the loan and any prepayment penalties. In order for this to be considered a valid exit strategy, the borrower must have a documented plan for improvement and/or data regarding his or her expectations of property value increases.
Exit Strategy 2: Refinance
Hard money loans can be taken out for many reasons. It may be that the borrower could not wait for traditional bank loan processes and needed to move quickly in order to get the property at the desired price. Or, it may be that their credit was not good enough to qualify for a bank loan. But these circumstances can change and the borrower may be interested in refinancing his or her hard money loan through a bank at a later date. Additionally, under-market rents may be brought to market making the property more attractive to conventional lenders, or small business lenders may open up their lending practices and make loans more widely available.
Exit Strategy 3: Self-Amortizing
Self-amortizing is simple math. It involves paying your principal and interest payments during the full duration of your hard money loan so that the loan is completely paid off by the maturity date. If this is your exit strategy, be prepared to show how you plan to create the income from your property to allow for you to make these payments.
Exit Strategy 4: The Sale of Other Assets
There are many other assets that a borrower may own and can sell in order to pay off their hard money loan. While they may not have been able to wait for the sale of other assets before they bought or extracted equity from the property in question, once the loan is issued and the property value secured, a sale of other assets can be given the time to take place. The borrower may sell off other real estate, business interests, bonds or other securities. This activity turns the hard money loan into a bridge loan. The borrower may even access funds within his or her self-directed IRA to pay off the note.
Exit Strategy 5: The Combo
A combination of any of the above exit strategies can also create another, blended exit strategy. For instance, the sale of other assets insufficient to pay off the loan entirely may reduce the LTV enough that a conventional lender will become willing to step in and finance the rest. Or, some large loan payments combined with the sale of assets could result in a paid off loan. The possibilities are endless.
There is no limit to the possibility of compliant exit strategies for a hard money loan. Borrowers should not feel overly restricted by the necessity of an exit strategy, but instead should open themselves up to the many possible solutions available to them for exiting the loan.