What is a Hard Money Loan?
A hard money loan is a short-term loan secured by real estate typically used by real estate investors and developers. Unlike traditional mortgages hard money loans are based primarily on the value of the property being used as collateral, rather than the borrower’s creditworthiness. This makes them a viable option for borrowers with poor credit or those who don’t qualify for traditional financing.
How Do Hard Money Loans Work?
Here’s a breakdown of how hard money loans work:
Borrower:
- Applies for a hard money loan from a private lender or company.
- Provides the property as collateral.
- Typically has a lower credit score or doesn’t qualify for traditional financing.
Lender:
- Approves the loan based on the property’s value and the borrower’s ability to repay the loan.
- Provides the loan funds to the borrower.
- Charges a higher interest rate and fees compared to traditional mortgages.
Repayment:
- The borrower repays the loan with interest over a short period, usually 6 to 18 months.
- If the borrower defaults on the loan, the lender can foreclose on the property.
Pros and Cons of Hard Money Loans
Pros:
- Fast approval process: Hard money loans can be approved in a matter of days, compared to weeks or months for traditional mortgages.
- Less stringent credit requirements: Borrowers with poor credit or no credit history can still qualify for hard money loans.
- Flexible terms: Hard money lenders are often more willing to negotiate loan terms than traditional lenders.
- Access to capital: Hard money loans can provide borrowers with the capital they need to purchase or renovate a property quickly.
Cons:
- High interest rates: Hard money loans typically have much higher interest rates than traditional mortgages.
- Shorter repayment terms: Hard money loans usually have shorter repayment terms, which can make them more difficult to repay.
- Large down payments: Hard money lenders often require larger down payments than traditional lenders.
- Risk of foreclosure: If the borrower defaults on the loan, the lender can foreclose on the property.
When to Consider a Hard Money Loan
Hard money loans can be a good option for borrowers who:
- Need to close on a property quickly.
- Don’t qualify for a traditional mortgage.
- Need access to capital to renovate a property.
- Are comfortable with the risks involved.
Alternatives to Hard Money Loans
- Private money loans: Borrow money from family, friends, or other private investors.
- Home equity line of credit (HELOC): Use the equity in your home as collateral for a line of credit.
- HomeStyle loan: A government-backed mortgage that allows you to renovate your home.
Frequently Asked Questions
What are the typical terms for hard money loans?
Hard money loans typically have terms of 6 to 18 months and loan amounts ranging from 70% to 80% of the property’s value.
What are the risks of a hard money loan?
The biggest risk of a hard money loan is missing payments or not selling the property in time to cover the loan. This can lead to foreclosure and significant financial loss.
What are the benefits of a hard money loan?
Hard money loans offer several benefits, including fast approval, flexible terms, and access to capital. However, it’s important to weigh these benefits against the risks before taking out a hard money loan.
Hard money loans can be a useful tool for real estate investors and developers, but they come with significant risks. Before taking out a hard money loan, it’s important to understand the terms, risks, and alternatives available.
Interest Rates on Hard Money Loans
Interest rates on hard money loans are typically higher than those on conventional mortgages. July 2020: As of July 2022, the average interest rate for a hard money loan ranged from 2010 to 2018. This results in much more expensive hard money loans than a regular mortgage, which during the same month offered an interest rate of between 4% and 5%.
For flippers and short-term investors, this might not matter. They might intend to repay the loan quickly, which would lessen the impact of a high interest rate and lower the cost of the loan. However, it makes sense for the majority of other people to search for a loan with a lower interest rate. A hard money loan’s main benefit is speed; if you can wait a few months for it to process, you might be better off refinancing your house or applying for a personal loan.
Special Considerations for Hard Money Loans
Because the lender is taking on more risk by providing the financing, the cost of a hard money loan to the borrower is usually higher than that of financing offered by banks or government lending programs. But quicker access to funding, a looser approval procedure, and possible repayment schedule flexibility come at the cost of the higher cost.