Hard money lending is quite a unique form of lending. It is generally used for real estate transactions, but goes outside of traditional mortgages and other such lenders. Usually, the money is provided by investors, which can be individuals or groups, who are looking at the feasibility of providing short term loans with relatively higher interest rates. If a traditional lender denies someone a loan, or if someone needs money fast, then hard money may be the best option out there.
Understanding Hard Money Loans
No matter what type of loan you take out, the lender will want to have proof that shows you can afford it. Generally, this means looking at your income and credit score. If you have a good history that shows you have repaid your debt, and you have a good debt to income ratio, then most lenders will approve you. However, determining this is a long and slow process, even if you have a fantastic income and perfect credit score. On the other hand, if you have a few negative marks, or a complex form of income, then things take even longer and you may even get declined.
A hard money lender looks at things differently. What matters to them is your collateral, which they will secure the loan against. This means that your repayment ability is a lot less important. Should you find yourself in financial difficulties, the lender will simply take your collateral and sell it on. Hence, it is the value of this collateral that is the determining factor, not your personal financial situation.
A loan of “last resort” or a short-term bridge loan. Hard money loans are backed by the value of the property, not by the credit worthiness of the borrower. Since the property itself is used as the only protection against default by the borrower, hard money loans have lower loan-to-value (LTV) ratios than traditional loans.
In most cases, a hard money loan is a short term loan, lasting no more than five years. They have very high interest rates, which is why most people wouldn’t want to have the loan for longer than absolutely necessary anyway.
Why Should You Consider a Hard Money Loan
A hard money loan is very costly, and that is its greatest disadvantage. However, there are a number of situations in which it can be very beneficial.
Hard money loans are right for both short-term investors and long-term investors. Specifically, hard money loans are used by Fix-and-Flippers, Buy-and-Hold Investors, and Portfolio Investors.
There are a number of key reasons as to why these types of investors would look to hard lending:
- Speed – Because the focus is on collateral rather than financial positions, a loan can be approved and closed very rapidly. Naturally, these lenders don’t want to repossess your property, but they have a lot less risk as they don’t have to verify your income. You build a relationship with a lender and the process is then incredibly quick.
- Flexibility – Hard money loans don’t go through regular underwriting processes, evaluating individuals instead. You have the possibility to change your methods of repayment, not in the least because you are likely to work with an individual, rather than a huge national bank that has stringent policies.
- Approval – Since these types of loans are secured against a piece of property, you can generally borrow as much as the value of your property. Negative pointers on your credit report, such as past foreclosures, are much less important. While lenders will usually view your credit, they won’t generally base their decision on that.
- Low LTV (Loan-to-Value) ratios. Usually, you can get an LTV of between 50% and 70%. While this means that you do need some assets, the ratio is much lower than what it would be on an investment property with a traditional lender. Again, this is because the lenders know they can get their investment back quite easily should you not pay back.
When Should You Consider a Hard Money Loan?
A hard money loan should only be taken out for short term loans because of their high interest rates, as stated. This is why they are so popular with fix and flip properties.
Hard money lenders will charge 2-5 points and 12-18 percent interest, although some hard money lenders will allow a smaller down payment and finance some repairs. The catch is hard money lenders like to work with experienced flippers and usually only offer their best loans to repeat customers.
With fix and flip investments, a property is purchased, fixed, and sold within no more than a year in most cases. The goal is simply to purchase a property and sell it for a profit in as short a time as possible. If the property isn’t sold, and investors decide to live there while waiting for the value to increase, they will generally look at a refinance option so as to get better value.
The Disadvantages of Hard Money Loans
While the hard money loan has some key benefits, it has some drawbacks as well. The biggest is that it is a very expensive form of lending, which means lenders must anticipate significant profits if they want to end up with profit. Furthermore, the way that properties are valued is also often different from traditional lenders.
The interest rates on hard money loans are incredibly high. This is why these loans should be considered if you are sure that you won’t be accepted anywhere else. There are numerous loans available for people with poor credit or complex income scenarios, and you may want to consider those first, even if they take longer to close. An FHA 203k loan could be an option, for instance.
An FHA 203k loan is a loan backed by the federal government and given to buyers who want to buy a damaged or older home and do repairs on it.
How to Find a Hard Money Loan
In order to be accepted for a hard money loan, you have to find an investor. This means you have to research who offers this type of money in your local area. Real estate investor groups and real estate agents are usually a good place to get those important connections. Make sure you speak to a number of different lenders before you decide to sign up.