Hard Money Loan Overview – What Is a Hard Money Loan?

A hard money loan, sometimes known as a bridge loan, is provided by private investors or other non-traditional lenders. In this arrangement, the asset being acquired serves as collateral for the loan, lowering the risk for the lender as well as the borrower.

Quick closings between the sale and purchase of a property necessitate the usage of hard money loans. As a bridge to a more permanent loan, they might be utilized to help a buyer get into a house quickly.

Most of the time, these types of loans are put to use in the construction or buying of real estate. Some investors may purchase houses that are in need of work, do those repairs, and afterward sell the property for a profit. 

The fast and simple financing option of a hard money loan can be quite attractive to real estate investors. Borrowers with poor credit may choose these loans, but the huge interest rates and short repayment periods should be considered a risk.

Let’s take a look at the pitfalls associated with hard money loans and weigh their benefits and drawbacks.

How Do Hard Money Loans Work?

A hard money loan allows you to borrow funds for real estate investments outside of the conventional mortgage market. You’ll need to turn to private lenders or investors who are more interested in the property itself to provide the capital you need.

To qualify for a traditional mortgage loan, you’ll need to show that you can afford the payments. Loan companies use a borrower’s income and credit history to determine if they are a good risk. You may not need to bother thinking if you have a stable source of income, substantial savings, or access to additional collateralized credit.

It gets more complicated if you have a bad credit score, a source of income that is hard to prove, or a high debt-to-income ratio.

How to Get a Hard Money Loan

Contact financial firms that focus on hard money loans to find one. Real estate professionals and investor groups in your area can provide a list of potential contacts.

In the case of hard money loans, the creditor will determine whether or not to give financing depending on the appraised value of the collateralized property. Unlike with a traditional loan, the creditor will likely only undertake a cursory check of your credit and finances. 

Borrowers can anticipate receiving their funds in a short amount of time rather than weeks or months thanks to this streamlined procedure. However, the creditor carries on a lot more risk, which means the debtor has to pay more for the loan. Although it varies by the creditor, hard money loans are known for their high-interest rates and often substantial down deposits.

In addition, the terms of hard money loans are typically quite brief, lasting at most a few years. This is in contrast to traditional mortgage terms of 15 or 30 years.

Hard Money Loans: Pros and Cons

If a hard money loan is something you’re considering, it’s important to weigh the benefits against the drawbacks.

Pros

• Loan terms that are flexible. Having collateral for a hard money loan can up for a less-than-perfect credit history. As they are not subject to the same rules and regulations as traditional mortgage lenders, hard money creditors are sometimes more amenable to negotiating favorable loan terms.

• Quick Funding. Hard money loans can even be processed in days, whereas traditional mortgage underwriting might take weeks. In the real estate industry, time is of the essence in terms of making a deal, especially if other investors are interested in the same property.

• No need for a strong credit record. A high FICO score or piles of financial paperwork are not prerequisites for obtaining a hard money loan. Hard money creditors provide loans regardless of the debtor’s income or credit history, instead basing their decisions on the value of the collateral, which could be a home or other real estate. 
  
  Thus, it is important for debtors to provide an estimate of the property’s market value once all planned repairs have been made.

Cons

• Costs increase. Loans from a hard money creditor will typically have higher interest rates than a more conventional loan option. Interest rates are often far higher than those for traditional mortgages, and closing costs can be prohibitive. 
  
  There is a hefty down payment requirement and closing charges that are likely to be high. Paying up your loan earlier than the agreed-upon period may result in additional fees known as a prepayment penalty.

• Loan-to-value (LTV) ratios that are conservative. To be approved for a hard money loan, you’ll need substantial assets. The normal loan-to-value (LTV) ratio demanded by hard money lenders is between 50% and 70%. 
  
  That’s a lot more cautious than the norm for mortgages. For example, Fannie Mae allows LTVs between 75% and 97%, depending on the circumstances.

• Strict rules on the lending of money at high interest. State and federal laws prohibit hard money lenders from extending credit to debtors who are unable to repay their loans. Hard money creditors are required by law to prove that their debtors can afford both their regular payments and any required balloon payment.

Who Is a Hard Money Loan Best Suited For?

Debtors usually look for a hard money loan since they either can’t get approved for a traditional loan or need the money immediately. Hard money loans are often accessible much more quickly than traditional mortgages, which might take several weeks to close.

Hard money loans are best suited for short-term endeavors, for instance when an investor plans to swiftly fix up and sell a home for a profit. Repayment terms for these loans typically range from one to five years.

Some people get a hard money loan to make repairs to a property, subsequently, refinance to a traditional mortgage at a more favorable interest rate.

Hard money lenders typically work with the following sorts of borrowers:

• “Flippers” are people who acquire houses, fix them up, and then resell properties for a profit.
• Borrowers who don’t meet the criteria for traditional loans
• Homeowners who have a lot of equity in their property but are nonetheless facing foreclosure

Is a Hard Money Loan Worth It?

It’s not perfect to get a hard money loan. Although at first glance hard money appears like the best option—a collateralized loan makes everyone involved feel safe—it does have some drawbacks.

The added expenses may be one of the main drawbacks of using hard currency. The cost of borrowing in this manner is high. The interest rates are high, and there could be additional expenses such as those for the closing or for processing your application.

It’s also perilous to have a limited amount of time to do something. For instance, if a major setback occurs or unforeseen structural issues are discovered during a house renovation, the homeowner may find themselves short on cash or paying more in interest than anticipated.

Finally, the method used by creditors to determine the worth of your home could be more costly than you anticipate. For instance, you may not have enough money for labor and supplies if the lender demanded a 30% down payment after you had anticipated one for 20%.

Alternatives to Hard Money Loans

Besides hard money loans, there may be more attractive options for financing a rental property. Here are some of them:

1. Another mortgage. A home equity loan or line of credit (HELOC) is a type of loan that can be obtained by homeowners. You’ll have to put up your current property as collateral, but the interest rate could be significantly cheaper than what you’d spend for a hard money loan.

2. Using personal connections for funding. Friends, family, and other well-wishers who believe in your deal may be willing to help you financially. Though they may be willing to lend in advantageous conditions, you should nonetheless make the dangers of the loan clear and think about how it might affect your relationship.

3. Aid for borrowing from the government. If you intend to purchase and reside in a multi-unit property in the United States, you should investigate the financing programs offered by the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA). 
   
   There are loan programs available from the Small Business Administration (SBA) for entrepreneurs looking to invest in commercial real estate.

4. Vendor financing. When a property is sold with financing provided by the seller, the seller takes on the role of the loan provider. Even if your credit isn’t perfect, you still may be able to qualify for this unusual form of financing. 
   
   Expensive down payments and much less purchaser protection versus traditional loans are two potential drawbacks of the seller financing option.

Final Thoughts

If you’re in need of alternative financing, hard money loans could be a helpful option. These loans may seem like a good idea at first, but they carry a lot of risk and exorbitant interest rates in case your venture doesn’t pan out. In most cases, you should let a professional handle a hard money loan.

Hard money loans, according to most professionals, are only suitable for the short term and should not be used in place of a more permanent mortgage. Loans of this type require collateral in the form of either equity or real estate.

If you need money but have been turned down for a mortgage, you might try repairing your credit or applying to a type of financing such as the FHA loan program that works with borrowers who have less than perfect credit.