What comes to mind when you hear the term ‘hard money’? This term can be used in a number of financial contexts. With the coming of financial technology and increased access to banking for most of the population, hard money is not as popular as it was some decades ago. Interestingly, even with these developments, new reports show that hard money lending is on the rise. Before going into details of how hard money works and what good it is in the market, let’s slice up its definition.
What is Hard Money?
Hard money is used to define a funding stream from a government agency or a donor organization. In this case, it is used to describe a series and scheduled payments as opposed to a one-time award. In another hard money definition, it is just what it sounds – physical currency.
In another definition, hard money is circulating currency whose value ties directly to the value of a specific commodity. Think about notes or coins from precious metals such as gold, silver, and platinum. A good example of it is the Gold Standard.
You can also define hard money as the opposite of soft money. Here, it is perceived as physical cash or fiat money used to make payments, while soft money is either credit or any other money that is not physical or fiat and which is not backed by any commodity. You can also look at soft money as indirect contributions or fees for financial services such as brokerage fee.
The most important definition is in lending. In a lending context, it refers to a loan that is backed by a physical asset. Unlike traditional lending that considers credit rating and ability to pay, this loan is based on collateral as the lender considers the value of property vs the amount requested.
Let us focus on hard money definition in terms of lending.
What is it Good for?
What is the first thing that comes to mind when most people hear hard money lending? Some people envision a ruthless lender giving out money at sky-high interest rates, or a scam posing as lenders whose interest is in getting the property at a cheaper price from unsuspecting borrowers?
On the contrary, these loans are a fully-fledged industry. According to Forbes, flippers control about $56 billion markets. Private lending stakes about 5.6% of this market share. In 2016 alone, flippers borrowed around $18 billion. It is estimated that a third of these were financed through local land deals by getting hard money loans.
There is a growing demand for credit than conventional banking and mortgage industry can meet. So investors, particularly real estate investors and small businesses take advantage of this gap through private lending – hard money loans.
Hard money loans are good for;
- Small businesses that are overlooked by conventional banks and lenders
- People with poor credit rating
- Real estate investors that need quick cash to take advantage over a deal
- Construction and land loans
- Fix and flips
Basics of Loans
In lending can be described as asset-based financing where the borrower gets a loan secured by a property. While the reputation of the borrower matters, hard lenders are solely interested in the value of the property which serves as collateral.
Interest rates for the loans range between 7% and 35% depending on the need, risk, and terms of lending. Hard money loans carry a higher risk to the lender because most borrowers have a low credit rating. This is why their interests are higher. In the U.S., this borrowing is regulated and strictly governed.
Hard Money Loan to Value Ratios
Loan to Value (LTV) is the ratio used to determine the amount the lender will extend to the borrower. It is simply the ratio of the loan amount divided by the value of the property. Hard money lenders should loan up to 65% to 75% of the market value of the property. Some lenders use the after repair value (ARV) to estimate the value of the property. This increases the interest rate instead since it is riskier.
Hard money loans are popular among business people especially in real estate and small businesses. They allow you to save your business during a crisis or take advantage of a quick business deal, especially in property deals. When it comes to hard money definition, we will help you look at lending from all angles.