Many real estate investors want to know if they can use a hard money loan to cover the down payment on an investment property Hard money loans are a popular financing option for real estate investors, especially those just starting out who may not have a lot of cash on hand In this article, we’ll explain what hard money loans are, whether you can use them for a down payment, and the pros and cons of doing so.
What is a Hard Money Loan?
A hard money loan is a short-term loan issued by private investors instead of banks or mortgage lenders. These loans are collateralized by the property being purchased, meaning the property itself secures the loan.
Hard money loans are appealing to real estate investors because they can be obtained much faster than traditional bank financing The application and approval process is streamlined, and investors can sometimes get funds in their account in just a few days
However, hard money loans come at a price. Interest rates are much higher than conventional mortgages, often between 8-15%. Loan terms are short, usually 6 months to 3 years. Hard money lenders also charge origination fees of 2-5% of the loan amount.
Can You Use a Hard Money Loan for a Down Payment?
Yes, hard money loans can be used to cover some or all of the down payment on an investment property purchase. Many real estate investors seek these loans specifically for this purpose when they don’t have enough cash on hand to cover the down payment.
Some key things to know:
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Hard money lenders generally lend up to 65-75% of a property’s value. So you’ll still need to come up with 25-35% down in most cases.
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Interest rates and fees are high, so this is an expensive way to finance a down payment. Make sure your investment deal pencils out.
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Hard money loans have short terms of 1-3 years. You’ll need to refinance into a longer term loan or sell the property before the loan matures.
The Pros of Using Hard Money for a Down Payment
Using a hard money loan for the down payment offers some advantages:
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Speed – You can access funds much faster than with a conventional mortgage. This allows you to jump on investment opportunities quickly.
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Easier to qualify – Hard money lenders focus more on the property’s value rather than your finances and credit. If you won’t qualify for a bank loan, hard money may be your only option.
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Purchase flexibility – Hard money provides more flexibility to purchase investment properties like multifamily, fix and flips, and commercial buildings that banks shy away from.
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Renovation money – Many hard money loans will finance both the purchase price and rehab costs to fix up an investment property.
The Cons of Using Hard Money for a Down Payment
There are also some potential disadvantages:
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High rates and fees – The high interest rates and hefty origination fees make hard money expensive. This cuts into your investment returns.
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Risk – If you default, you could lose your down payment and the property. The short repayment terms also give you a narrow window to flip or refinance the property.
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Prepayment penalties – Hard money loans often charge a penalty equal to 6 months interest if you pay off the loan early.
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Equity requirements – Even with a hard money loan, you’ll likely need around 25% of the purchase price in cash to meet the lender’s LTV requirements.
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Qualifying for refinancing – You may have trouble qualifying for a loan to refinance your hard money debt later due to the short repayment history.
Tips for Using Hard Money for a Down Payment
If you do opt to use hard money for your real estate investment down payment, keep these tips in mind:
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Shop around with multiple hard money lenders to compare rates and fees. Look for the best deal.
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See if you can negotiate a lower origination fee or interest rate by putting up more equity.
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Pay for an appraisal to confirm the property value before moving forward with the loan.
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Have a solid exit strategy, like securing take-out financing or identifying multiple exit buyers. Don’t rely on a hot sales market.
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Only use hard money for great deals that can withstand the high costs and maximize your profit. Avoid overpaying.
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If possible, limit your hard money borrowing by putting up some of your own cash alongside the loan.
The Bottom Line
Hard money loans allow real estate investors to tap into financing for a down payment much more quickly than traditional lenders. But these loans come with much higher rates and costs. As such, hard money loans for down payments involve substantial risk.
Investors should fully understand these risks and have a well-defined exit strategy before moving forward. While hard money loans can kickstart your real estate investing career, improper use can also sink your business quickly under the weight of expensive debt. Proceed with caution.
How To Calculate Hard Money Loan Down Payment
For most borrowers, a down payment of 20% will be required in order to initiate a hard money loan. If you are an experienced house flipper, you can potentially put less money down. The 20% down payment is based on the After Repair Value (ARV) of the investment property.
If you’re new to private lending, you might not be familiar with how the hard money loan down payment process works. A common question that many borrowers have is how much of their own money they need to put down when taking out a loan of this nature. The answer is that the down payment amount will differ depending on the hard money lender that you choose to go with. Regardless of which hard money lender you settle on, almost all of them will require a down payment of some sort.
Do Hard Money Lenders Require Down Payment?
In most cases, yes. It is common for hard money lenders to require between 10 and 25 percent of the purchase price. If you have a high credit score and lots of experience, you can potentially put less money down. Conversely, if you have a low credit score and very little experience, you may need to put more money down than a more experienced real estate investor with a high credit score.
Should You Use Hard Money Loans For A Down Payment?
FAQ
Can I borrow money for a down payment?
What Cannot be used for a down payment?
How do payments on hard money loans work?
Why not use a hard money lender?
How much down payment do you need for a hard money loan?
Being able to provide a portfolio of previous work may help your cause. Typically, hard money lenders require a down payment of 20% to 35%. Hard money loans come with higher interest rates and shorter terms than traditional mortgage loans. This can make them higher risk for some borrowers. • Rates: Interest rates can range from 8% to 15%.
Can I borrow money to make a down payment?
Borrow 80% with a first mortgage and use a home equity loan or HELOC for the remaining 10%, leaving you with just a 10% down payment.When your home sells, you can pay off the home equity loan or HELOC,
Is a hard money loan a good idea?
Hard money loans typically require a down payment of 20% to 35%, come with an interest rate of 8% to 15%, and must be paid off within six months to a few years. This makes them high risk for some borrowers, but the fast funding and de-emphasis on credit history can be appealing.
What is the 20% down payment on a hard money loan?
The 20% down payment is based on the After Repair Value (ARV) of the investment property. If you’re new to private lending, you might not be familiar with how the hard money loan down payment process works.