What Is a Hard Money Loan?
A hard money loan is a loan from a private lender that is secured by a tangible asset, such as real property. These loans generally have shorter terms and higher rates than traditional mortgages.
Definition of a hard money loan
A hard money loan is a loan from a private or non-traditional lender. The acquired asset is used as collateral for the loan, reducing risk for both the borrower and the lender.
Alternative definition: a loan that bridges the gap between an investment purchase and long-term financing.
Alternative name: short-term bridging loan
Hard money loans are used for quick responses between buying and selling a property. They can also be used to quickly finance a home, until the buyer gets a traditional loan.
These loans are generally used in real estate. Some investors buy houses in need of repair, repair them, and sell them at a profit. This is known as an investment and it can be difficult to get financing.
Other real estate investors can use hard money loans for commercial or rental properties if they cannot find conventional financing.
How Does a Hard Money Loan Work?
A hard money loan is a way to borrow money for real estate without going through traditional mortgage lenders. Instead, the funds come from individuals or investors who lend money primarily based on the property you are using as collateral.
Traditional home loans require proof that you can comfortably pay the debt. Lenders often review your credit score and any disposable income to assess your creditworthiness. If you have enough income, savings, or can get another secured loan, you may not have to worry.
However, the process becomes more challenging if you have a low credit score, a source of income that is difficult to verify to the satisfaction of the creditor, or a high debt-to-income ratio.
Hard money lenders are primarily concerned with the value of the collateral that guarantees the loan. They are less concerned about your credit score and income than traditional residential mortgage lenders.
If something goes wrong and you can't repay the loan, hard money lenders hope to get their money back by taking the collateral and selling it.
Hard money loans are generally short-term loans with a duration of one to three years. You use them as a quick way to get cash on a purchase.
However, you don't want to keep one of these loans for a long time because the interest rates on hard money are generally relatively high. For example, the average interest rate for hard money loans in 2020 was 11.25%.
Do I Need a Hard Money Loan?
Hard money may be appropriate if you can't get traditional financing to buy your property. Since traditional lenders focus on the value of your collateral, strong cash can close faster than other loans.
The hard money lender may not spend as much time as traditional lenders reviewing your application (although they still want to make sure you pay them back). For example, they may not spend a lot of time checking your sources of income or reviewing your bank statement.
Once you establish a relationship with a lender, additional financing processes can move quickly, giving you the ability to close deals that others cannot. This is useful in hot markets when properties receive multiple offers.
If you can qualify for other forms of financing, you can go ahead with traditional loans. For example, FHA loans allow you to borrow with less than perfect credit, have low down payment requirements, and may have lower rates than a hard money loan.
Hard money agreements can be more flexible than traditional loan agreements. For example, depending on your situation, you can adjust things like the payment schedule or other stricter features that a traditional lender will not negotiate.
The most important factor for hard money lenders is the collateral that secures the loan. Since the property acts as collateral, it is easier to get approved for an investment property.
You may also be borrowing money from someone who is willing to work directly with you, not a global institution with strict policies.
Is a Hard Money Loan Worth It?
A hard money loan is not perfect. While it sounds simple, an asset guarantees the loan so all parties are safe, hard money also has its drawbacks.
The main downside to hard money may be the additional costs you incur. This is an expensive method of borrowing. Interest rates are relatively high, and you may have to pay closing costs or other fees to obtain financing.
Foreclosure or other negative items on your credit report are less important to the approval process for a hard money loan.
A short period of time can also be risky. For example, if things don't go as planned, such as a material delay or structural surprises during a home renovation, you may face reduced cash flow or pay more interest than you expected.
Finally, the way that lenders value your property can drain your resources more than expected. For example, if your lender required a 30% down payment when you expected a 20% payment, there may be a shortage of capital for labor and materials.
What It Means for Individual Investors
While approval can be quick and easy, most lenders keep loan value ratios (LTV ratios or the ratio of loan value to home value) relatively low. The maximum LTV ratio tends to drop between 65% and 75%, so you will need assets to qualify for the hard money.
With conservative rates, lenders know they can sell their property relatively quickly and have a reasonable chance of getting their money back.
Hard money loans make more sense for short-term loans. Repair and exchange investors are a prime example of hard money users - they own a property long enough to improve it, increase the property's value, and sell it as soon as possible.
Hard money borrowers can expect to sell a property and repay the loan in a year or more. It may be possible to use hard money to buy a property you want to live in. You could, but you would like to refinance as soon as you get a loan with lower rates and a longer loan term.
How to get a Big Money Loan
To find a hard money loan, you will need to contact institutions that specialize in these types of transactions. Quick Internet searches for hard money lenders can usually reveal several lenders in your area.
Local real estate agents and real estate investor groups are a good source of names. Talk to multiple lenders, discuss your needs, and develop a relationship so you can quickly and easily finance projects when needed.
This helps with research, as hard money loans are less regulated. You can find lower rates or negotiate different terms with different lenders.
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