When loans need to happen quickly, or when traditional lenders will not approve a loan, hard money may be the only option. Let’s review how these loans work.
What is Hard Money?
Hard money loans are primarily utilized for real estate transactions and are money from an individual or company and not a bank.
A hard money loan, usually taken out for a short time, is a way to raise money quickly, but at a higher cost and lower LTV ratio.
Because hard money loans are not traditionally executed, the funding time frame is reduced immensely.
Terms of hard money loans can often be negotiated between the lender and the borrower. These loans typically use the property as collateral.
Repayment can lead to default and still result in a profitable transaction for the lender.
How are hard money loans differ from traditional loans?
Hard money loans have terms of 6 to 18 months, while traditional loans are typically amortized over 30 years.
Hard money loans usually carry an interest rate that’s 4% to 10% higher than traditional loans.
Hard money loans are intended for short-term investors, while traditional loans are for owner-occupied properties.
Hard money loans are backed only by property as collateral, while traditional loans are backed by the property and the borrower’s personal credit.
It’s important to keep these differences in mind when you’re considering different ways of financing your real estate investment.
What Types of Deals Should Hard Money Loans Be Used For?
Hard money loans are not appropriate for all deals. When purchasing a primary residence with good credit, income history, and there are no issues such as a short sale or foreclosure, conventional financing through a bank is the best way to go if the borrower still has time to go through the lengthy approval process required by a bank. Hard money is your source of financing when banks are not an option or the loan is needed in a short period of time.
Hard money loans are ideal for situations such as:
Fix and Flips
When the Buyer has credit issues.
When a real estate investor needs to act quickly.
Why Use Hard Money?
If hard money is expensive, why would you use it? Hard money has its place for certain borrowers who cannot get traditional funding when they need it.
Speed: because the lender is mostly focused on collateral (and less concerned with your financial position), hard money loans can be closed more quickly than traditional loans. Lenders would rather not take possession of your property, but they don’t need to spend as much time going through a loan application with a fine-toothed comb – verifying your income, reviewing bank statements, and so on. Once you have a relationship with a lender, the process can move quickly, giving you the ability to close deals that others can’t close (that’s especially important in hot markets with multiple offers).
Flexibility: hard money agreements can also be more flexible than traditional loan agreements. Lenders don’t use a standardized underwriting process. Instead, they evaluate each deal individually. Depending on your situation, you may be able to tweak things like the repayment schedules. You might be borrowing from an individual who’s willing to talk – not a large corporation with strict policies.
Approval: the most important factor for hard money lenders is collateral. If you’re buying an investment property, the lender will lend as much as the property is worth. If you need to borrow against a different property you own, that property’s value is what the lender cares about. If you’ve got a foreclosure or other negative items in your credit report, it’s much less important – some lenders might not even look at your credit (although many lenders will ask about your personal finances).
Most hard money lenders keep loan-to-value ratios (LTV ratios) relatively low. Their maximum LTV ratio might be 50% to 70%, so you’ll need assets to qualify for hard money. With ratios this low, lenders know they can sell your property quickly and have a reasonable shot at getting their money back.