What is hard money loan?

Definition of Hard Money Loan

How does a hard money loan work?

Do I need a hard money loan?

Is a hard money loan worth it?

What does it mean for individual investors?

How can I obtain a hard money loan?

Definition of Hard Money Loan

A hard money loan is a loan from a private lender secured by a tangible asset, such as real estate. These loans are granted by private lenders for investment purposes. The interest rates on these loans are typically higher and the terms are much shorter than traditional loans. The asset that you take the loan for becomes collateral for the loan, thereby reducing the lender’s risk.

How does a hard money loan work?

A hard money loan is a way to borrow funds to purchase real estate without using traditional mortgage lenders. Instead, the money comes from individuals or investors who are willing to lend money based on the underlying value of the property you are using as collateral.

Traditional mortgage loans require you to demonstrate your ability to repay the debt easily. Lenders often review your credit scores and any available income to assess your creditworthiness. If you have a lot of income or savings, or if you can secure another loan backed by different collateral, you might not need to worry.

However, the process becomes more challenging if you have a low credit score or a source of income that is difficult to verify to your lender’s satisfaction, or a high debt-to-income ratio.

Note: Hard money lenders primarily concern themselves with the value of the collateral securing the loan. They are less worried about your credit scores and income than traditional mortgage lenders.

If anything goes wrong and you cannot repay the loan, hard money lenders expect to recover their funds by taking and selling the collateral.

Hard money loans are typically short-term loans, lasting from one to three years. They are used as a quick means to obtain cash for a purchase. However, you do not want to hold one of these loans for an extended period because the interest rates on hard money are usually relatively high. For example, the average interest rate for hard money loans in 2020 was 11.25%.

Do I need a hard money loan?

A hard money loan may be suitable if you cannot obtain traditional financing to purchase your property. Because traditional lenders focus on the value of your collateral, a hard money loan can be closed more quickly than other loans.

A hard money lender is likely to spend less time reviewing your application than traditional lenders (although they still want to ensure you will repay them). For example, they may not spend much time verifying your income sources or reviewing your bank statements.

Once you establish a relationship with a lender, subsequent financing can move quickly, giving you the ability to close deals that others may not be able to close. This is beneficial in active markets when properties receive multiple offers.

Note: If you qualify for other forms of financing, you may be better off with traditional loans. For example, Federal Housing Administration loans allow you to borrow despite imperfect credit and may have lower down payment requirements and lower rates than hard money loans.

Hard money loan agreements can be more flexible than traditional loan agreements. For example, depending on your situation, you may be able to negotiate terms such as repayment schedules or more strict features that a traditional lender would not negotiate.

Most important

A factor for hard money lenders is the collateral that secures the loan. Since the property serves as collateral, it becomes easier to get approval for an investment property.

You may also borrow money from someone willing to work directly with you – not a large institution with strict policies.

Is a hard money loan worth it?

A hard money loan is not ideal. While it seems straightforward – with the asset securing the loan, all parties are safe – a hard money loan has its drawbacks as well.

One major drawback of a hard money loan could be the additional costs incurred. It is an expensive way to borrow. Interest rates are relatively high, and you may have to pay closing costs or other fees to secure financing.

Note: The process relying on your credit report or any other negative items in your credit report diminishes the importance of the approval process for a hard money loan.

The short time frame can also be risky. For example, if things don’t go according to plan, such as a physical delay or structural surprises during a home renovation, you could face cash flow pressure or pay more interest than you expected.

Finally, the lender’s valuation method may underestimate your property’s value more than you expected. For instance, if the lender requests a 30% down payment when you were expecting a 20% one, you may find yourself short on capital for labor and materials.

What does this mean for individual investors?

While approval can be quick and easy, most hard money lenders keep the loan-to-value ratio (LTV) relatively low. The maximum loan ratio tends to range between 65% and 75%, so you’ll need assets to qualify for a hard money loan.

With conservative ratios, lenders know they can sell your property relatively quickly and have a reasonable chance of recovering their funds.

Hard money loans are most suitable for short-term loans. Investors who buy properties, improve them, increase the property value, and sell them as quickly as possible are an excellent example of hard money users.

Hard money borrowers may hope to sell the property and repay the loan within about a year. It may also be possible to use hard money to buy a property you wish to live in. You can, but you’ll want to refinance once you secure a loan with lower rates and a longer loan term.

How can I get a hard money loan?

To find a hard money loan, you’ll need to reach out to institutions that specialize in this type of transaction. A quick online search can reveal many hard money lenders in your area.

Local real estate agencies and real estate investor groups are good sources for names. Connect with several lenders, discuss your needs, and build a relationship so you can fund projects quickly and easily when needed.

It’s helpful to shop around since hard money loans are less regulated. You may be able to find lower rates or negotiate different terms with different lenders.

Source: https://www.thebalancemoney.com/hard-money-basics-315413

“`