Hard money loans are an incredibly useful financing tool that can help you stave off foreclosure or continue to maintain your business for future growth and profits. Unfortunately, most people either do not know what hard money loans are or are untrustworthy of them. You may be depriving yourself of a convenient loan source. To ease your fears, let’s take a closer look at hard money loans and how they work.
With most loans, you have to submit proof that you can actually repay the lender by the end of the loan period. With a conventional loan, that usually means providing a lender with your credit score, your income, employment history, debt history, and other financial information, all to determine if you are a responsible borrower and have the means to repay the loan.
Hard money loans are short-term bridge loans that are supported by the actual value of the property or asset instead of a person’s credit worthiness. With a hard money loan, the property itself is used as the only collateral or protection against default from the borrower, so the lender has to worry less about your ability to repay. If anything goes wrong or if you fail to repay, the lender can get their money back by taking the property and selling it, which makes the value of the collateral more important than your credit history.
Hard money loans are designed to be short-term loans reserved mainly for quick turnaround situations, short-term financing, or borrowers who have poor credit but high equity in their properties. Most hard money loans generally only last one to five years. Due to the risks involved, banks and other traditional lenders usually will not offer hard money loans. Instead, most hard money loans come from private individuals or small groups that might see value in the investment.
Types of Property Used for Hard Money Loans
Although they can potentially be used for any type of asset, hard money loans are generally isolated to forms of property, including:
- Single family homes
- Residential properties
- Multi-family residences
- Commercial properties
- Industrial property
- Land ownership
However, some hard money lenders will specialize in one type of property. For instance, one lender may only work with residential properties and not be able to help with commercial buildings, mainly based on the lack of experience. When you do work with a hard money lender, it’s a good idea to be upfront and ask them the type of properties they are willing and able to work with.
Furthermore, because of increasing rules and regulations, many hard money lenders will not provide money to a residential property that is occupied by the owner, but some lenders may be willing to deal with the extra paperwork needed to help the borrower.
Interest Rates and Mortgage Points
Interest rates and points can vary based on the lender, state, and region. For example, hard money lenders in California will likely have lower interest rates because the state has more hard money lenders than most (more lenders means greater competitions, which means lower rates to compensate).
Generally, hard money loans come with higher interest rates than traditional loans because of the inherent risk that they present. Interest rates for hard money loans can be as high as 15 percent based on the lender and the risk of the specific loan. Mortgage points, which are fees paid to the lender as a means of bringing down the interest, are a percentage of the total loan amount where one point equals one percent. For hard money loans, you could be looking at paying two to four points.
Loan-to-Value Ratios for Hard Money Loans
Loan-to-value ratios are the total loan amount divided by the value of the property. This is a simple way for hard money lenders to determine how much to loan you. Hard money loans tend to have a lower loan-to-value ratio than conventional loans. Most hard money lenders will offer 65 to 75 percent of the current value of the property.
However, some lenders will also lend based on the after-repair value (ARV). This is the estimated value of the property after you have performed all repairs and renovations. This is obviously riskier for the lender. There is no guarantee that the property will sell for that estimate, and the amount of money the lenders puts in goes up while the amount of capital that the borrower invests goes down.
Some lenders will lend a high ratio of the after-repair value, and some may even offer to cover the costs that go into the repair and rehab. That may sound great to you as a borrower, but most hard money lenders will charge an increased interest rate as a means of offsetting the greater risk. You could be looking at interest rates of about 15 to 18 percent on top of up to six points with little to no down payment from you. If you still think you can generate profit from this, it may be worth it to secure a deal.
As with any loan, hard money loans start with an application. Hard money loans will still require information on your credit history, income, personal assets, and other finances, but the application process will not be nearly as intensive or time-consuming as with a traditional loan. The main information that hard money lenders need involve the property, including:
- The purchase price
- Cost of repairs and rehab
- The after-repair value
The lender will also require an appraisal of the property. This is an accurate estimate of the property’s worth from a licensed professional.
If you do get a hard money loan, the lender will require you to create a draw schedule, which shows what you plan to actually do to the home and when. The lender will also use this schedule to determine when to give you your money. Instead of providing a single payment, most lenders will provide periodic payments when you need it.
Many lenders will require you to pay out the first draw before they reimburse you. In practice, this always means paying ahead by one draw until the last payment, when once the house is complete. This back and forth is how the lender protects themselves.
The Drawbacks to Hard Money Loans
Hard money loans are admittedly not perfect and have their drawbacks, the biggest being their cost. Simply put, hard money loans are expensive. You can expect to pay interest rates at least 10 percent higher than with traditional loans, on top of fees for origination, loan servicing, and closing.
Hard money loans also have a shorter repayment period. By nature, hard money loans are designed to help you get a property ready and on the market as quickly as possible. That is usually good for you, but that inevitably means shorter repayment plans, which means you have to know how profitable a property will be and how soon you will see those profits, so that you can repay your loans.
The Benefits of Hard Money Loans
In spite of the high costs and risks involved, hard money loans have their place for borrowers who cannot get more conventional forms of funding. The biggest benefit to hard money loans is the speed and convenience. The lender is more focused on the collateral and its value and less worried about you’re the borrowers creditworthiness. Lenders do not have to spend as much time analyzing your loan application, and verifying your income and finances.
This generally equates to much faster closing. Where traditional loans may take a few months to close, hard money lenders can provide funding within as soon as one week. Once you have built a solid relationship with your lender, the process can generally go fairly quickly. This can be even more advantageous in competitive markets where many people may be bidding on one property. The sooner you get your loan, the faster you can purchase that property.
Hard money loans also have a distinct flexibility that can’t be found with most traditional loans. Hard money lenders tend to be private investors who do not have a standard underwriting process, meaning they rarely have set loan terms. Many will evaluate deals on an individual basis, and depending on the situation, you may be able to negotiate everything from repayment schedules to origination fees. These lenders are actual humans, not large companies with strict policies.
The approval process for hard money loans is also much simpler because you are using the property as collateral. You may have foreclosures or other negative items in your credit history, but the main thing that hard money lenders care about is the property value. Many lenders will be even more lenient, allowing you to use a residential property you own, retirement accounts, or other personal assets to secure a loan.
When to Use a Hard Money Loan
Drawbacks and benefits aside, hard money loans are not the perfect choice for all investments. They make the most sense for short-term loans, specifically fix-and-flip investments, where a person plans to buy a home, repair it, and put it back on the market at a higher price, all usually within one year.
While it is certainly possible to use a hard money loan to pay for a property that you plan to live in, you should refinance as soon as you have the chance to get a better loan so that you don’t have to suffer from the high interest rates. If you want to buy a primary residence that you plan to occupy and you have good credit, income, and time, you should consider going through a bank or other traditional loan avenue. Hard money is best reserved for situations when you can’t go through the lengthy approval process or can’t get a loan from a bank.
You should ideally use hard money loans if you:
- Want to fix and flip a home
- Need a land loan
- Need a construction loan
- Have prior credit issues
- Need to act quickly to invest in a real estate property
Del Toro Loan Services has the tools, knowledge, and experienced personnel to provide tailored services for all loan services, including hard money. If you have any questions or would like to learn more, please don’t hesitate to contact us today.