A hard money loan is a unique financial construction. It is a short term loan and is offered as interest only. These loans are perfect for those wanting to purchase distressed rehab properties, for which it is impossible to get a traditional mortgage. The interest rate on a hard money loan tends to be a lot higher, with averages of around 12%. However, they can be completed in as little as 15 days and they usually run for no longer than a year, after which the property can be flipped.
Anyone interested in investing in properties very quickly, therefore, may want to consider this type of loan. While they are expensive, they are also quick and reasonably easy to obtain. This makes them interesting for those who would otherwise be declined.
When applying for a loan from a normal financial institution, you will be expected to meet many hard-set requirements. […] As long as you have a high-value asset with at least 20% equity stake in it, there are good chances that you will qualify for the loan.
How Do Private Loans Work?
Private loans are designed to help fund a real estate investment’s purchase and renovation. They are quick to obtain, particularly compared to a traditional mortgage, and they have very flexible acceptance criteria. Fix and flippers, who buy and sell properties within a year, are particularly interested in them.
In addition, they can also be beneficial for a long term investor who holds a property but then switches to a traditional mortgage after renovating a property. As such, the timeline of investment is not so important. Rather, it is about needing money to buy a property that is in disrepair and having the funds for the repairs. Typically, people only pay interest back on their hard money loan while it is running. Generally speaking, these loans also have no prepayment penalties.
While lenders want their money back also – interest is still important to them. When you prepay, you are cutting into the overall interest a lender can earn on financing your loan.
What this means is that, should you complete the work on the property sooner than expected, you can pay off the loan sooner as well. Typically, investors like these types of loans because they pay out so quickly and have minimal requirements. These benefits are so great, in fact, that they are happy to pay more for the loans. Interest rates usually range between 7% and 12%, and lender fees (points) are between 1% and 10%.
Should You Take out a Hard Money Loan?
If you are a short term investor, such as a fix and flipper who doesn’t intend to hold a property for more than 12 months, then you may want to consider a hard money loan. If you are a long term investor, then you should really only consider this type of loan if you know that you will be approved for a more traditional, long term, affordable loan after a reasonably short period of time. Typically, two kinds of investors will consider private lending.
First, there are the fix and flip investors.
Fix and flipping homes may seem like a pretty simple concept. Buy a house that needs some work, fix it up and sell the house. The truth is it takes a lot of time to find the right deal, find the right financing, find the right contractor, decide what to repair, maintain a property, value a property, make sure all the needed repairs are done and then sell the house. Fix and flipping is not something you can spend a couple of hours on a week and be successful.
The reason why fix and flippers look for a hard money loan is because it allows them to finance the purchase price of the property and the money required to pay for the work that needs to be done on the property. Hence, fix and flippers try to find homes in a very poor condition, fix it rapidly, and sell it for, sometimes, huge profit. They find these properties through lender owned REO listings, foreclosure auctions, and short sales.
Usually, investors are able to receive a private loan based on the ARV (after repair value) of the property. They receive the funds, buy the property, and fix it using their hard money line of credit. These investors do have to have some money themselves in order to be accepted for these loans, not in the least because they may have to float rehab costs as it can take a little bit of time before the lender pays out. Once renovations are completed, they sell the property and pay back the lender.
The second type of investor interested in private loans is the buy and hold investor.
Buy and hold is a passive investment strategy for which an investor buys stocks and holds them for a long period regardless of fluctuations in the market. An investor who employs a buy-and-hold strategy actively selects stocks but is not concerned with short-term price movements and technical indicators.
Typically, these investors use a hard money loan to purchase and fix a property. Once that is completed, they take out a traditional mortgage on the property itself and pay off their private loan. They then hold the property, either for them to live in or rent out to tenants and become a landlord. Buy and hold investors looking for a hard money loan generally purchase distressed properties, which means a traditional lender will not fund the deal. This means that they bridge the time period between buying and fixing the property and it becoming a property that a traditional bank would be happy to provide a loan for As such, the loan in this case can be seen as a type of bridging loan.
Qualifying for a Hard Money Loan
Whether you are a fix and flip or a buy and hold investor, one of the biggest benefits of the hard money loan is that it is so easy to qualify. The approval process is also incredibly rapid. However, you do have to be realistic about the serious financial commitment you are making.