Hard money loans are a form of financing where a borrower uses real estate as collateral. These loans are an excellent alternative when traditional financing is not an option. They are a safe financing alternative popular among realtors.
Read on to find out more about hard money loans. By the end of this article, you will have all the knowledge you need to determine whether a hard money loan is a financing option you should consider.
- What are hard money loans?
In a few words, a hard money loan is a short-term loan against real estate.
According to Investopedia, hard money loans are classified as short-term bridge loans, i.e., a short-term loan you can use until you secure traditional financing. However, hard money loans are primarily used in real estate transactions.
The lender, typically an individual or company as opposed to a financial institution, is more interested in the value of the property you are providing as collateral. The property could be one you already own or the one you are looking to acquire once you secure financing.
Hard money lenders do not care much about your creditworthiness. They look at the deal you are looking to finance. Are you getting the property at a discount? Do your after-repair-value projections make sense? Can you renovate and sell the property in time to repay the loan?
- What are the advantages of hard money loans?
Hard money loans are expensive. The interest rates might be up to 10 percentage points higher than interests on loans from traditional financial institutions. The closing costs and origination fees are also relatively higher. Additionally, the repayment period is significantly shorter than conventional loans.
So, with those drawbacks, why would you still consider a hard money lender?
- Speed: Hard money lenders can process your loan in less than two weeks. These lenders are mostly concerned with the collateral. They do not take time to go through your financial history keenly. Time is a critical factor in the real estate market, where if you are too slow to act, you lose a lucrative deal.
- Reduced red tape: To secure a traditional loan, the lender has to check your credit score, debt-to-income, loan-to-value ratio, and other factors that might disqualify you. Hard money lenders are mostly concerned with the value of the property for which you are securing a loan.
- Flexibility: Here, you are dealing with an individual or company who you can negotiate with and reach favorable terms. Banks use a standardized underwriting process, which is not very flexible and does not consider your specific needs.
- What are the main differences between hard money loans and traditional loans?
- Hard money loans have short repayment terms. Most lenders want their money back in 1.5 years max, although some might allow up to three years. On the other hand, you can have as much as 30 years to repay a traditional loan to finance the purchase of the real estate.
- Hard money loans have higher interest rates, typically 4 to 10 percentage points above the interest rates offered by banks.
- The security for a hard money loan is property while traditional loans lenders look for creditworthiness and collateral.
- Hard money loans are convenient for financing real estate deal and investment properties, while traditional loans are for owner-occupied homes.
Understanding these differences helps you decide if a hard money loan is the best option or you should consider other real estate financing methods.
- What are the typical hard money loan terms?
The terms for a hard money loan are dependent on the lender and geographical location. However, typically the interest rates are above 7%, and the origination fees can go up to 3%. Obviously, experience flippers get more favorable terms as the lender perceives the investment as less risky.
Some lenders will finance as much as 100% of the property value. However, to increase your chances of qualifying, provide a down payment of about 10%. The lender will get their money back through the collateral. The down payment helps them see you are serious as you would not want to lose your money.
- When to use a hard money loan?
Hard money loans are convenient for short-term purposes. Typically, they are used when financing a real estate deal. Financial experts recommend using a hard money loan to finance a fix-and-flip deal, where you are sure the property will be out of your hands in a short period.
You can also use a hard money loan to acquire property before you can secure long-term financing. You will use the funding you get from your bank to pay the hard money lender.
- Where to find hard money lenders?
If you are new to this type of financing, you are probably not sure where to find hard money lenders. The best place to start is your network. Ask other real estate agents where you can find a reliable hard money lender. You could even ask your traditional lender to recommend hard money lenders you could do get in bed with.
Another viable option is Google. Search for “Hard money lender” and visit the websites of the companies in the results pages. Ascertain the credibility of lenders you find online by checking reviews and asking for referrals.
- What to look for in a hard money lender?
- Reputation: Check online reviews, ask for references, and ask other realtors about the credibility of a lender before you commit.
- Adequate funding: You do not want to negotiate terms only to realize when it is too late that the lender cannot provide the amount of money you need.
- Sensible fees and interest rates: Hard money lenders are not regulated like financial institutions. So, it is up to you to determine whether the costs of the loan are worth it or the lender is taking advantage of you.