The Real Deal on Hard Money Loan Rates

Hard money loans can seem like an attractive option when you need funding fast for a real estate investment. But before you jump in, it’s important to understand the real costs involved – especially the interest rates. In this comprehensive guide, we’ll break down everything you need to know about hard money loan rates.

What is a Hard Money Loan?

A hard money loan is a short-term loan issued by private lenders or investors rather than traditional banks or mortgage lenders. These loans are asset-based meaning they are issued based on the value of the underlying asset being financed – usually an investment property – rather than the borrower’s creditworthiness.

Hard money loans are popular with real estate investors since they can be obtained much faster than traditional bank financing. The underwriting is also less strict, making them more accessible to borrowers banks may deem too risky.

The tradeoff is that hard money loans come with higher interest rates and costs. Let’s take a closer look at why this is the case.

Why Are Hard Money Loan Rates So High?

On average, interest rates for hard money loans fall between 10% and 18% – significantly higher than rates for conventional mortgages. There are a few key reasons for this:

• Higher Risk – Hard money lenders take on greater risk because they do not follow standard underwriting guidelines. Instead, they base approval mainly on the property’s value. If the borrower defaults they can foreclose and sell the property to recover their capital.

• Shorter Terms – Most hard money loans have 1-3 year terms, The short repayment period reduces the lender’s risk exposure

• Variable Rates – Hard money loans often have variable rates that fluctuate based on an index like the Prime Rate. This transfers interest rate risk to the borrower.

• Higher Costs – Hard money lenders have higher overhead costs and must charge higher rates to be profitable. They also lend in smaller amounts, so each loan costs more on a percentage basis.

• Lack of Regulation – Hard money lenders are not regulated like banks, so they can set rates more freely based on risk.

Taking on these higher risks allows hard money lenders to provide fast financing that borrowers may not be able to obtain elsewhere. But the borrower pays for this convenience via higher rates and costs.

Typical Hard Money Loan Rates

While hard money loan rates can vary significantly, most fall within the following ranges:

• Interest Rate – 10% to 15% is typical, with an average around 12%. However, for riskier loans or higher-value properties, rates can potentially reach 18% or more.

• Points – 1 point to 5 points are common. Points are an upfront fee paid to the lender, with each point equal to 1% of the loan amount. More points may help secure a lower interest rate.

• Origination Fees – 2% to 6% is standard. This fee covers the lender’s administrative costs.

In total, the combined costs on a 12-month $500,000 hard money loan could look like this:

• Interest rate: 12%
• 3 points charged ($15,000)
• 5% origination fee ($25,000)

That results in $90,000 in total costs – an 18% effective rate – that must be repaid along with the principal.

Factors That Impact Hard Money Loan Rates

When evaluating a potential hard money loan, keep in mind that several factors can result in a higher or lower interest rate:

Property Type – Multi-family and commercial properties are considered less risky, while vacant land or speculative projects draw higher rates. Owner-occupied residential properties tend to fall somewhere in between.

Loan-to-Value (LTV) Ratio – Loans under 60% LTV receive better rates, while LTVs over 75% are costlier due to the increased risk.

Credit Score – A credit score of 700+ may qualify for 10% or lower, while scores under 600 could result in rates above 15%. However, credit is less important than with traditional loans.

Loan Term – Shorter terms of 6 months get lower rates. For terms beyond 12 months, rates rise significantly.

Loan Purpose – Cash-out or new construction loans are riskier than purchases or refinances, warranting higher rates.

Experience – First-time borrowers pay more. Repeat borrowers with a track record may get better deals.

Location – Loans in stable, in-demand markets get lower rates than unstable or rural markets.

Lender Competition – In high-competition areas, lenders may offer more rate incentives to win business.

Common Misconceptions About Hard Money Rates

There are a few common misconceptions about hard money loan rates that investors should be aware of:

• “Rates Are Always 12%” – In reality, rates vary widely based on individual risk factors. While 12% is a decent average, the actual rate could be lower or higher.

• “Points Lower the Rate” – While paying points may help secure a lower rate, that is not always the case. Points compensate the lender for risk but don’t necessarily reduce the rate.

• “Credit Doesn’t Matter” – Most hard money lenders still examine a borrower’s credit profile. Strong credit can potentially help obtain a better rate.

• “Shorter Terms Mean Lower Rates” – Short terms do reduce risk, but they also decrease the lender’s potential profit. So term length doesn’t always affect rates linearly.

• “Hard Money Is Cheaper Than Banks” – Hard money provides faster access to capital but is almost always a costlier financing option compared to traditional bank loans.

Ways to Reduce Your Hard Money Loan Rate

While hard money loans are expensive, here are a few tips that may help secure a lower rate:

• Shop Around – Get quotes from multiple lenders to negotiate the best deal possible. Rates and fees can vary significantly between providers.

• Increase Your Down Payment – A down payment of at least 30% shows the lender you have skin in the game and lowers their risk.

• Pay Discount Points – Offer to pay additional points to buy down the interest rate. Each point typically lowers the rate by 0.25%.

• Shorten the Term – Opt for a 6-12 month term rather than longer periods of 2-3 years.

• Pay Interest Upfront – Paying all interest owed at closing reduces risk for the lender.

• Use an Equity Partner – Bringing in a partner to guarantee a portion of the loan may help improve terms.

• Build a Relationship – Working repeatedly with the same lender can lead to better customer pricing over time.

Weighing the Costs and Benefits

Hard money loans provide quick access to capital that would be hard to obtain through traditional channels for many real estate investors. However, that financing convenience comes at a steep price.

It’s critical to carefully assess your business plan and exit strategy to determine if paying 10-18% interest and hefty fees will still allow your deal to yield a reasonable profit. Running the numbers with a higher cost of capital may reveal that certain projects only pencil out with traditional bank financing.

However, deals requiring speed and less stringent qualifications may justify a hard money loan, even with expensive rates. As with any financial decision, thoroughly understanding both the costs and benefits is key to determining if it aligns with your real estate investment objectives and risk tolerance.

Key Takeaways on Hard Money Loan Rates

• Hard money loans carry interest rates averaging 10-18%, much higher than traditional mortgages
• Short terms, variable rates, and higher risk account for the increased costs
• Many factors like property type, LTV, credit, and loan purpose influence rates
• There are some ways to potentially secure a lower hard money loan rate
• Carefully weigh if the benefits outweigh the higher costs for your scenario

Understanding the actual rates and costs is essential when evaluating hard money loans. While they provide ready capital, the long-term profitability relies on having realistic expectations. With the right project under the right conditions, hard money can be an effective tool. But it’s critical to run the numbers and enter informed based on current real-world rates.