If the phrase “hard money loan” makes you think of quick and easy business deals that end in “cold, hard cash,” you’re not too far off the mark. However, just because this type of loan offers fast financing doesn’t mean it’s a good, safe option for everyone.
So, what are hard money loans and should you be wary of them? Let’s examine what you should look out for and also consider the pros and cons of hard money loans.
Hard money loans may not be difficult to get, but they can be expensive. Despite the cost, they’re an essential tool for investors. Knowing when to use hard money and how to get it is critical.
Here’s everything you need to know about using hard money loans for real estate.
What is a Hard Money Loan?
A hard money loan is a short-term, non-conforming loan for commercial or investment properties, that doesn’t come from traditional lenders, but rather people or private companies that accept property or an asset as collateral. Commercial borrowers may turn to hard money loans after having a loan or mortgage application denied, or to avoid the lengthy process of getting approved for a loan through traditional means.
Like a traditional mortgage, a hard money loan is a secured loan, guaranteed by the property it’s being used to purchase, but a hard money loan can also be cross-collateralized by other real estate the borrower owns or retirement accounts. This flexibility is an advantage of hard money lending.
Hard money loans tend to rely more on the collateral through which they are secured as opposed to the borrower’s financial history. The “hard” part of “hard money” refers to the tangible asset being used to back the value of the loan. When someone defaults on a secured loan, the lender can take ownership of the asset to recoup its losses.
Unlike traditional mortgages or other types of secured loans, hard money loans come with a fast and typically less stringent approval process, making them ideal if a purchase needs to happen fairly quickly.
With a traditional mortgage, it often takes more than a month, from application to close, to purchase a property. With hard money loans, it’s possible to close in just a few days.
Hard Money Loan vs. Conventional Loan
There are some distinct differences between a hard money loan and a conventional loan, for example:
- Hard money loans aren’t offered by a traditional lender and instead come from a private source.
- A hard money loan isn’t offered by a traditional lender and instead comes from a private source.A hard money loan is better suited to an investor, whereas a conventional loan is best for a buyer planning to live in a residence they’re borrowing against.
- A hard money loan typically requires less documentation than a conventional loan, and they aren’t as focused on the borrower’s credit scores.
- A hard money loan doesn’t require as large of a down payment as a conventional loan.
- A hard money lender requires you to repay the loan in less time than a conventional lender.
- A hard money loan often comes with a higher interest rate than a conventional bank loan.
It’s important to carefully review the terms and fees associated with a hard money loan and the lender’s reputation before taking on debt from a company. These types of hard money loans are ideal for investors who want to buy property for rental income purposes.
How Does a Hard Money Loan Work?
Unlike a traditional lender, a hard money lender is far more interested in the asset that will serve as the collateral for the loan than they are the borrower borrowing against that asset.
With hard money loans, the lender approves a borrower based on the value of the property being purchased.
The lender may do a quick check of your credit or finances, but in general, the process will be much less rigorous than with a traditional loan. This allows the process to happen more quickly so borrowers can get their money in a matter of days instead of weeks or even months.
The hard money lender takes on significantly more risk, which translates to a more expensive loan for the borrower. Hard money loans typically come with high interest rates, and lenders might require larger-than-average down payments (though this isn’t always the case).
Banks normally have very strict and arduous criteria for traditional mortgages, especially mortgages on an investment property. This is particularly true once you’ve acquired over ten properties in your name and are no longer eligible for a Fannie Mae–backed loan.
While traditional banks prefer owner-occupied properties that are turnkey and move-in ready, most real estate investors don’t make money with these turnkey cookie-cutter properties, so hard money lending can be extremely useful.
While most hard money is lent out for investment grade single family homes, hard money lenders offer loans on multifamily apartments, commercial office buildings, industrial property, retail, and even on items that aren’t real estate investments, such as equipment purchases.
At first glance, hard money and private money loans appear to be the same, but they are quite different.
Hard money lenders are effective brokers for short-term loans, mostly on real estate.
Private lenders, on the other hand, can be just about anyone who has money. A private loan is relationship-based; the lender could be a private company, friend, or family member.
Many investors use hard money as an integral part of their financing strategy — particularly those who need loans to fix and flip. It’s a great tool to get money quickly if you know how to use it in the right way.
Hard Money Lending and Real Estate
As noted above, the standard terms for hard money loans are expensive and can come with higher interest rates. But since these are short-term loans, they can still be absorbed with room for a healthy profit. While each hard money lender is different, normally, real estate loan terms look like this.
- Loan to value/loan to cost 65%–85%.
- Lend on rehab costs: yes.
- Interest rate: 12%–16%.
- Points: 2-6.
- Other fees (will vary by lender):
- Appraisal/broker’s price opinion.
- Title fees.
- Application fee.
- Inspection fee.
- Document processing fees.
- Term: six months to one year.
- Prepayment penalty: usually none.
A broker’s price opinion (BPO) usually ranges from $150 to $250, and an appraisal can range from $400 to $650 (or substantially more if it’s a multifamily or commercial property).
The LTV typically depends on the value of the property for example most lenders will go up to 75% of the loan-to-value (LTV) or loan-to-cost (LTC), loaning up to 65% of the after-repair value (ARV) if that value is higher.
This means that on rare occasions, they have financed 100% of the cost of the property. This only happens for particularly good deals, however. Don’t go into a deal expecting this.
Other hard money lenders may max out at 65% LTV, while some may increase to 85%. Remember to clarify whether a lender is referring to the LTV (what the property is worth) or the LTC (how much money you will be putting into the property).
Regardless, you will almost always need to find a way to raise the down payment. Potential sources include savings, a partnership, or a personal loan from friends or family. In certain cases and with some lenders, another free and clear property can be cross-collateralized.
The bottom line is that hard money lenders are generally more flexible than banks. Real estate investors have a better chance of negotiating adjustments to the terms or repayment schedule with a hard money lender than they would with a bank.
What To Know About Working With Hard Money Lenders
Hard money lenders are generally private investors or companies that deal specifically in this type of lending. You won’t find hard money loan options at your local bank. Hard money lenders aren’t subject to the same regulations as traditional, conforming loan lenders. As a result, hard money lenders are, for the most part, free to make their own rules about credit scores or debt-to-income ratios they require from their borrowers.
It’s possible to find a hard money lender who will give you a loan even if you’ve been denied by more traditional lenders. Again for hard money lenders, the most important factor isn’t the borrower’s creditworthiness, but the value of the property being purchased.
As with any financing, you must be careful and should vet the lender the same way you would any other lender, and thoroughly review the terms. You will need to consider your situation to find the best hard money lender for your needs. Is this your first property? Or are you an experienced flipper? Are you looking for someone focused on your needs? Someone fast? Which hard money lenders can you afford? Which hard money lender has the best reputation in your area?
These are some of the questions you should ask yourself when looking for a lender.
Don’t be afraid to ask for referrals, either. Good lenders won’t have a problem providing them.
Pros and Cons of a Hard Money Loan
Given that hard money lenders are more expensive than banks; it makes sense to go the hard money lending route if you can’t get a bank loan upfront. Traditional purchases or properties that don’t need much rehab are not the best candidates for hard money loans.
On the other hand, properties that you intend to flip and those requiring substantial rehab are good candidates for hard money lending. This is particularly true if you have some hiccups on your credit report or don’t have a W-2 income.
Banks are obsessed with W-2 income. While many will lend to full-time real estate investors, many will not — at least not to anyone without a long, proven track record.
The pros and cons of hard money loans depend on your situation, but let’s go through them:
Hard money loan pros
- They’re quick.
- The loan review isn’t as arduous as with banks.
- Borrowers who can’t get a conventional loan often qualify.
- Properties that need too much work for a bank to be interested in often qualify.
- They’re available if a traditional loan falls through while the property is under contract.
Hard money loan cons
- The cost of the loan can be expensive, with high-interest rates and miscellaneous fees.
- They’re risky to jump into since your property is collateral.
- Repayment periods are shorter.
- May require a track record of successful house flips
Alternatives to Hard Money Loans
If you’re unsure about hard money lending and its associated risks, you might be wondering if there are any alternatives to hard money loans for investors. There are several other options you can consider if you don’t want to work with a hard money lender, including:
1. Home equity line of credit (HELOC)
With a HELOC, you can use the equity you have in your home as a line of credit without actually having to pull the equity out of your home. You’ll borrow against the equity you’ve built up, turning your asset into collateral that you can use to invest in another property. Of course, doing this means you’ll have a lien against your home, but you’ll pay this down over time and hopefully make money off your investment in the meantime.
2. Cash-out refinance
A cash-out refinance when you actually pull out the equity you’ve built up in your home and use it to purchase an asset. It’s basically taking out another mortgage or increasing the mortgage you already have on your home. This can be a good move if you don’t owe much on your home or the interest rates are better at the time you want to refinance and pull cash out of your home’s equity. There are fees associated with a cash-out refinance, which will increase your monthly mortgage payment, so consult an adviser to ensure this is the right move for you.
3. Home equity investment products
Home equity investment products are another alternative to hard money lending. These products also allow you to use the equity you’ve acquired in your home, but you won’t have to worry about paying the money back right away. This gives you flexibility with your investment plan. You can often get the money you need quickly when you opt to use a home equity investment product.
4. Family or friends
Family and friends with extra cash may be willing to loan you money to purchase a real estate investment property. If you’re a first-time investor, this can be an especially appealing route, as you can negotiate the best terms for you. A friend or family member may be more willing to work around your investment needs and be more lenient with payback terms and conditions. It’s likely that you can get a better interest rate from friends and family than you can from a traditional lender or one who offers hard money loans.
How Much do Hard Money Lenders Charge?
As noted, hard money loans are expensive. Just how expensive? Let’s compare interest rates on these loans to more traditional loan types.
In February 2023, the average rate on a conventional 30-year fixed-rate mortgage was 6.32%, according to Freddie Mac. Hard money loans can have much higher interest rates, often 12–16%.
Hard money loans can also be more expensive depending on the preferred loan-to-value (LTV) ratio of the lender. If a lender will only finance 70 – 80% (or less) of the property’s value, you’ll likely need to bring a sizable down payment to the closing table. If you don’t have the cash for this, you might have a tough time finding a hard money lender who will work with you.
How To Get a Hard Money Loan
For private investors, the best part of getting a hard money loan is that it is simpler than getting a traditional mortgage from a bank. The approval process is generally much less intense. Banks can ask for an almost endless series of documents and take several weeks to months to get a loan approved. Most hard money lenders can close a loan in as little as 5 to 10 business days.
It is generally best to start building relationships with hard money lenders well in advance of searching for properties and definitely prior to making any offers. This increases the likelihood of getting a deal done, as much of the groundwork has been laid before you need the money.
Many hard money lenders will also provide a conditional approval letter, which acts similarly to a bank’s preapproval letter. Most sellers require it before they’ll sign and accept your purchase offer.
Hard money lenders still have a loan application form to fill out. They also generally request two years of tax returns, two months’ worth of bank statements, an inventory of your own real estate, a copy of your driver’s license, and other personal information. They pull your credit score however, most hard money lenders will work with people who don’t have great credit, as this isn’t their biggest concern.
There isn’t nearly as much paperwork or detail as there is with a traditional loan. The main purpose is to make sure the borrower has an exit strategy and isn’t in financial ruin.
The most important thing hard money lenders will look at is the investment property itself. Hard money lenders will request a BPO or an appraisal to assess the property’s current as-is value or determine the ARV.
They will also evaluate the borrower’s scope of work and budget to ensure it’s realistic. Sometimes, they will stop the process because they either believe the property is too far gone or the rehab budget is unrealistic.
Finally, they will evaluate the BPO or appraisal and the sales and/or rental comps to ensure they agree with the evaluation.
While the process isn’t as simple as filling out a form and pulling out money there is another advantage built into this process: You get a second set of eyes on your deal and one that is materially invested in the project’s outcome at that!
If a deal is bad, you can be fairly confident that a hard money lender won’t touch it. However, you should never use that as an excuse to forgo your own due diligence.
If you, or someone you know is considering Buying or Selling a Home in Columbus, Ohio please contact The Opland Group. We offer professional real estate advice and look forward to helping you achieve your real estate goals! Call or text us at 614.332.6984.
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