Should You Get a Hard Money Loan for Your Primary Residence?

Purchasing your first home is an exciting milestone. But figuring out how to finance such a large purchase can be daunting especially if you have less-than-perfect credit or limited funds for a down payment.

You may have come across hard money loans in your research and wondered if they could be a good option. Hard money loans provide quick access to financing, but they also come with risks that make them a poor choice for primary residences.

In this article, we’ll break down what hard money loans are, their pros and cons who they are best suited for and better alternatives for financing your primary residence.

What Are Hard Money Loans?

Hard money loans are a type of short-term financing provided by private lenders, usually for real estate purchases. The loans are secured by the property itself.

Unlike traditional mortgages from banks, hard money loans have higher interest rates and shorter repayment terms of 1-3 years. They also require a higher down payment, often 20-30% of the purchase price.

The main benefit of these loans is that they can be obtained very quickly, sometimes in a matter of days. Approval depends more on the property value rather than the borrower’s credit score or debt-to-income ratio.

Hard money loans are frequently used by real estate investors and house flippers who need fast access to capital for a project. But some homeowners also use them if they don’t qualify for other types of financing.

Pros and Cons of Hard Money Loans

Hard money loans offer some advantages but also have considerable drawbacks, especially when used to purchase a primary residence.

Pros

• Fast approval: Hard money loans can fund your purchase much faster than a traditional mortgage.

• Less stringent criteria: Approval is based more on the property value rather than your credit score or income. This helps borrowers who may not qualify for other loans.

• Works with private lenders: This provides more flexibility than traditional bank loans.

Cons

• High interest rates: Expect rates of 10-15% or even higher, compared to 3-6% for traditional mortgages. This results in much higher costs over the loan term.

• Large down payment required: You’ll need around 20-30% down, making hard money loans difficult for first-time buyers without a lot of cash.

• Short repayment terms: Hard money loans typically need to be paid back in 1-3 years. This requires refinancing to a longer-term product.

• Risk of foreclosure: If you can’t repay the loan or refinance within the term, you could lose your home.

• Expensive origination costs: Points and fees can equal 5-6% of the total loan amount.

As you can see, the risks and costs generally outweigh the benefits when using a hard money loan to buy your primary home.

Who Are Hard Money Loans Best For?

Given the drawbacks, hard money loans are best suited for real estate investors who need quick financing for a flip or rental property purchase.

Investors can accept the higher costs and risks because they plan to refinance or sell the property for a profit within the short loan term.

Owner-occupants, on the other hand, intend to live in the home long-term. The high interest rates and possibility of foreclosure make hard money loans a poor fit for primary residences.

Hard money loans also appeal to borrowers with the following situations:

• Poor credit or income that disqualifies other mortgages
• Uneven income sources like seasonal work or commission-based pay
• Self-employed without adequate business history to document income
• Recent bankruptcy or foreclosure
• Large cash reserves for down payment but poor credit record

However, homebuyers with these challenging financial scenarios still have alternatives more suitable than hard money loans.

Hard Money Loan Requirements

While hard money loans are easier to obtain than traditional mortgages, you still must meet certain requirements:

• Credit score: Each lender sets their own minimum, but scores of 600+ are typical.

• Down payment: At least 20-30% down is required. Loans do not exceed 70-80% loan-to-value ratio.

• Debt-to-income ratio: Standards vary but tend to be no more than 45%.

• Equity: For owner-occupants, lenders want to see equity in your current home if applicable. This helps ensure collateral for the loan.

• Property value: The lender will assess the property’s value to determine maximum loan amount and loan-to-value ratio.

Hard money lenders need to confirm you have resources to repay the loan or enough equity to recoup their money if you default. That’s why large down payments and existing home equity are often required.

Alternatives to Hard Money Loans

The good news is that if your finances don’t meet traditional mortgage standards, you still have alternatives more suitable than hard money loans for buying your primary residence.

FHA Loans

FHA loans are government-insured mortgages that offer:

• Low down payments of just 3.5%
• Lenient credit requirements – 580+ FICO score
• Low interest rates
• Long 30-year loan term

These features make FHA loans much more affordable for primary residences.

VA Loans

VA loans help military members and veterans buy a home with no down payment at all. Credit scores of 620+ and a certificate of eligibility are required. VA loans also boast low rates and a 30-year term.

Subprime Mortgages

Subprime lenders specialize in applicants with credit challenges. They offer mortgages with higher rates than prime loans but still below hard money loan rates.

Loan Programs for Low-Income Buyers

Fannie Mae and Freddie Mac have HomeReady and Home Possible loans requiring just 3% down and credit scores as low as 660. These programs can help low-income buyers purchase affordably.

Owner Financing

Sometimes sellers will finance a portion of the purchase price directly. This removes the need to fund 100% through a mortgage. Monthly payments go right to the seller instead of a bank.

Grants for Down Payment

First-time buyers may qualify for down payment assistance grants from state, local, or nonprofit programs. These funds gift a portion of the down payment and require no repayment.

The Bottom Line

Hard money loans provide quick access to capital for real estate purchases and appeal to those who can’t get traditional financing. However, the high costs and risks make them a poor solution for buying a primary residence.

As a homeowner, you need stable, affordable financing you can repay over decades, not years. An FHA, VA, or subprime mortgage are far better alternatives if you don’t initially qualify for a traditional bank loan.

Shop around with different lenders to see if you can be approved for one of these alternative mortgage programs. Many provide options for down payment assistance as well.

While getting a hard money loan for a primary residence is possible, it should really be viewed as a last resort. Exhaust other, less risky financing methods first. This helps ensure your home purchase sets you up for long-term financial success.