If you have mortgage needs that are outside the conventional mortgage box, such as real estate investing, then hard money lenders may be the answer to your short-term cash needs. But is it going to be the best option for you? Here’s all you need to know about hard money loans to make an informed choice.
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What is a Hard Money Loan?
Hard money loans are real estate loans based on the value of the collateral you’re offering, such as the property itself, rather than the ability you have to repay the loan to the lender. The various types of loans include:
- Fix-and-flip loan – These loans let a real estate flipper to buy a home to fix up fast so it can be sold for a profit and the loan repaid
- Bridge loan – These are intended to help someone buy a property fast with the goal of refinancing or reselling it. They also allow someone to buy a new property before they get enough for a down payment from the sale of a home they’re currently trying to sell.
- Construction loan – These are for real estate developers to quickly begin a new construction project with the goal of either selling it quickly once complete or refinancing it
- Owner-occupied loan – These allow a person who doesn’t qualify for other financing to purchase a property for their personal use
That’s just a quick overview of a few different hard money loan options. Remember, hard money lenders are private firms and individuals that may consider granting loans under different circumstances and on a case-by-case basis.
So, if you think you’re interested in a hard money loan but don’t fit into one of the situations above, don’t give up. You may find a lender who is willing to help you out.
What Kind of Properties Can You Buy?
A hard money loan can be used on pretty much any type of property, from single-family homes to land deal to commercial and industrial properties. You may find some lenders who specialize in loans for specific types of properties.
In fact, most hard money lenders operate in a niche because it’s something they’ve become familiar with. When you talk to a hard money lender, make sure to find out up front what kinds of loans they’re able or willing to do.
How Hard Money Loans Work
A hard money loan is not a loan available to just anyone. Most lenders won’t consider granting loans to people who aren’t real estate investors. If you think you may be able to get one for your private home, then you might be out of luck.
There are a few lenders who make hard money loans to consumers, but that wades into murky regulatory waters, so most lenders avoid it.
Hard money loans are only meant for short periods of time, normally less than a few years. In fact, most lenders use 12 month terms.
That means that payments aren’t applied equally to interest and principle. For a hard money loan, you normally only pay interest, and sometimes have no payment at all.
These loans have a few perks that are especially appealing to real estate investors, such as:
- Fast financing, sometimes in a week or less
- Short loan terms, usually one year or less
- Hassle-free application process
To qualify for a hard money loan, you often need to be able to put some of your own money down, too. Every lender is different, but they normally require a cash amount based on the Loan-To-Value (LTV) ratio or After-Repair-Ration of the property you’re looking to finance.
A lender may only give you a max of 80 percent of the LTV ratio, which means you’ll need to come up with the remaining 20 percent on your own.
The loan is then paid off at the end of the term with a balloon payment. This covers the entire principle of the loan and any interest that remains, along with any fees that originated with the loan. That’s pretty much it!
Conventional vs Hard Money Lenders
If real estate loans live on a spectrum, then on one end you have hard money loans and on the other end you’ll find traditional, conventional loans. They’re pretty much polar opposites of one another. The only thing they have in common is they’re issued to buy real property – that’s it.
Hard money loans are often provided by private organizations or individuals. They carry very different terms than the type of loans you find at your local bank.
Hard money loans usually have very high interest rates and very short repayment periods compared to other types of loans. But, unlike traditional loans, they’re fast and easy to apply for.
Why are they easier? While they have the same underwriting standards as more traditional loans, hard money lenders are more likely to be forgiving of things other lenders aren’t, such as recent bankruptcies, forecloses, or bad credit.
What a hard money lender cares about is the value of the property that serves as collateral and the loan to value ratio. Regular lenders tend to focus more on the credit rating and income of the borrower.
That’s not to say it’s a free-for-all. Since Dodd-Frank regulations have been put into place, the lender must verify the ability of the borrower to replay by analyzing their expenses and income to ensure that old debt-to-income ratio is right.
Plus, if lenders want to loan to private individuals, they have to undergo licensing requirements with the National Multistate Licensing System and Registry to do so.
That’s an expensive process to go through, which is why in most states you won’t find a lot of private lenders that issue owner-occupied loans.
Things to Consider
Hard money loans may seem like the answer to all your real estate prayers, but there are definitely some things you’ll want to consider before pursuing this type of loan. First, let’s talk about a few of the benefits of a hard money loan. These include:
- Fast money – You won’t spend months filling out forms for hard money loans. Real estate investors can apply and get funding usually in a matter of days.
- Flexible terms – You’re working with private firms and individuals with a hard money loan, not massive banking institutions. That means that the lender often has more customized loans available to fit your needs.
- Lenient requirements – A traditional mortgage requires certain standards of income, credit, and debt. Hard money lenders are required to look at those factors too, but they’re much more interested in collateral. In other words, if you have a property, then they will come.
- Increased opportunities in investments – When you have access to large amounts of flexible, fast cash, then you can usually swoop in to get in on the really great investment properties. That type of access can really make or break a real estate investor.
The Downfalls of Hard Money Lending
Even with all the value hard money loans can provide, there are a few disadvantages when it comes to them. These include:
- Lack of oversight – When compared with a more conventional consumer mortgage, there’s not a ton of government oversight on hard money loans, especially for the purpose of business. That’s why you really have to know what you’re getting yourself into before entering into the deal with a lender that may have dishonest motives.
- Short terms – The short lending terms are a blessing and a curse. It allows you not to carry the loan around for a long time, but it also means you need to sell or refinance the property relatively fast so you can pay the loan back when it comes due.
- High fees – A lot of lenders will pile on the fees for a hard money loan such as construction draw fees, early-repayment penalties, underwriting fees, and origination fees.
- High interest rates – On top of all those fees, hard money lenders also charge high interest rates, often into the double digits.
- Red tape for refinancing – If you need to refinance the loan with a traditional mortgage lender, then you can run into some trouble. That’s because it may be required for you to have owned the property for a certain period of time before you can refinance. This can throw a wrench into your plans if your hard money loan is due before you can refinance.
When to Use a Hard Money Loan
Hard money loans are normally used as a tool by real estate investors and they come quite in handy in a few situations. You may want to consider a hard money loan if:
- You have bad credit – Hard money loans are usually based on collateral, not your ability to repay. So, if you have bad credit and have hit a dead end with conventional mortgages, you may want to explore this option a bit more.
- You can’t get financing anywhere else – Real estate investments are tricky and getting a conventional mortgage is difficult in even normal circumstances. Banks don’t like to make loans for investments, either. If you’ve hit these roadblocks, then you might want to dig a little deeper into hard money loans to fund your investments.
- You need money quickly – Real estate markets can move fast and if you’re not ready to move in, you could really miss out on good investment opportunities. Hard money loans are a lot faster, getting you money quickly.
Should You Avoid Hard Money Lenders?
There’s no denying that hard money loans can open up a lot of real estate investment doors for you, but they can shut just as many. You should avoid these types of loans if:
- You don’t have a good plan – It’s absolutely essential to have a refinancing plan in place if you’re going to get a hard money loan. Although you may think you can simply sell your property before the loan is due, that may not happen. Know the requirements for refinancing before you sign on the dotted line for the loan.
- It’s a buyer’s market – Selling the home after rehabbing it is what most real estate investors have in mind, but if homes aren’t selling in your current market, then that may not be a reasonable expectation. If you can’t sell the home, then it’s time to refinance or risk getting foreclosed on by the lender.
- You have other options – It’s an unfortunate truth that hard money loans are expensive and can fall prey to predatory loan practices. They really should only be considered as a last resort and only be used by people who know what they’re doing. Do your due diligence and explore all loan options first.
How About Interest Rates?
If you bemoan the interest rates for credit cards, then you haven’t seen anything yet! That’s because hard money loans have about the same level of interest as a credit card but at an amount for a mortgage. Most hard money loans will charge between 5 percent APR and 15 percent APR or more.
The one saving grace of these interest rates is that they’re for the short term. With other mortgage loans or credit cards, you have decades to pay off the balance on the loan and pay interest on it. With a hard money loan, you’ll only carry it for a year or two.
Hard Money Lenders
You can use your old friend Google to help you find a hard money lender. However, like a box of chocolates, when you find a hard money lender via a Google search, you never know what you’re going to get. A few reputable hard money lenders you may want to look into include:
- Lima One Capital –Specialize in fix-and-flip hard money loans
- Visio Lending – If you’re a landlord looking to grow your rental portfolio, then this one is for you
- Delancey Street – For those who want a hard money loan for residential or commercial projects
- Patch of Land – For residential fix-and-flips as well as commercial real estate investors
- LendingHome – Fast and competitive funding for residential fix-and-flips
- Finance of American Commercial – For the development, purchase, and flip of commercial properties
- CoreVest – For large real estate portfolios, they offer loan limits up to $100 million
You can also find out who lends money based on collateral in your area through local real estate investor groups or real estate agents. They can provide you with names of investors to reach out to and discuss your planned projects.
How to Get a Hard Money Loan
If you have decided that a hard money loan is the right option for you and you have a lender, then how do you go about getting one? Pretty easily, it turns out.
A lender will want to make sure you fulfill their requirements to borrow money, as in you have a property to purchase for collateral. They’ll want to know what it’s worth, what the ARV will be, and what the appraisal on the property came back as.
And don’t forget you may need a down payment if the ARV is greater than its current value. Every lender is different, of course, and you may have to provide additional information or meet other standards. The only way to know if to ask the lender directly, then start the process!
The Hard Line on Hard Money
For some people, hard money loans are a great fit. But those are usually people with the real estate portfolio to back up their business interests. When you’re considering a hard money loan, pay close attention to loan terms, fees, and interest rates.
You know you’re going to pay more money for this type of loan, but you still don’t want to pay too much, otherwise it could tank your real estate venture before it even gets off the ground.