Hard money lending is a common term that gets thrown around by investors, particularly in real estate. For some, it’s a confusing concept, while for others, it can cause some reluctance. Hard money loans can be an immense tool that can help you stave off foreclosure or bankruptcy. Read on to learn more about hard money lending and how it can benefit you.
What is a Hard Money Loan?
Hard money loans are generally considered a last resort that is similar to a short-term bridge loan, which is a form of financing that provides a person or organization with money until they either remove an existing obligation or secure permanent financing. Bridge loans are designed to “bridge the gap” when an entity needs financing when it’s not yet available.
With most loans, the lender needs some form of proof that you can repay them, which usually means submitting your credit score, income, and employment information, all to show that you have a history of repaying on time and in full and actually have the ability to repay your loans. Unfortunately, even if you have great credit and sustainable income, approval can be a long, drawn out process, while negative items on your credit only make the approval process even harder.
Hard money loans are unique from other types of financing in that they are supported by the value of the property, not the borrower’s credit score or general credit worthiness. Hard money loans also tend to have lower loan-to-value ratios than other loans as the property itself is the only form of collateral.
Essentially, the lender is not worried about your ability to repay. If you experience any problems or otherwise can’t repay your loan, the lender will get any money back by taking the property as collateral and selling it. Hard money loans also have higher interest rates than traditional subprime loans, and are generally short term, lasting no more than five years.
Banks and other traditional lenders do not offer hard money loans due to the inherent risks involved. Most hard money lenders are private individuals or entities that see value in your investment.
Types of Property for Hard Money Loans
Hard money loans can be used on just about any type of property, from single family homes, to commercial buildings, to land. Some lenders will only specialize in a specific property type. For example, a lender may offer loans for land but not for residential properties – mainly because they don’t have any experience in them. When you seek a hard money loan, it’s a good idea to ask upfront if the lender specializes in any specific type of property.
Interest Rates and Points for Hard Money Loans
Interest rates and points vary from lender to lender and even region to region. Hard money lenders in California, for instance, generally have lower interest rates than those in other states because California has more hard money lending firms in general. More firms mean more competition, which equates to lower prices.
Hard money lenders naturally take on a lot more risk than conventional banks. That high risk on hard money loans often means higher interest rates. Depending on the lender and the perceived risk, you can expect interest rates ranging from 10 to 15 percent. Interest points can go up to four percent of the total loan amount.
Loan-to-Value Ratios for Hard Money Loans
The loan-to-value ratio is the loan amount divided by the value of the property. This helps determine how much the lender can actually loan out. Most hard money lenders will offer a loan-to-value ratio of 65 to 75 percent of the current value of the property.
Other lenders will loan based on the ARV, or after-repair value, which is the estimated value that the property may sell for once you have done repairs and improved the property, but this tends to be riskier for the lender. Loaning based on the after-repair value increases the amount of capital that the lender has to put in – all while decreasing the amount of capital invested by the borrower. This inevitably causes the higher interest rates.
Some hard money lenders will lend a higher percentage of the ARV while financing any costs for the repair and rehabilitation of the property. If this sounds too good to be true from the borrower’s perspective, that’s because it is. These types of loans run a much higher risk on top of even higher interest rates and points. You could be looking at up to 18 percent interest and 6 mortgage points without a down payment from the borrower. If you can still generate profit from the project, it may be worth it to pay these higher rates.
Potential Drawbacks to Hard Money Loans
The main drawback to hard money lending is the cost. While they are convenient, hard money loans come at a price to the investor and borrower. As stated above, you can usually expect much higher interest rates. On top of higher rates, you will also have to pay origination fees, loan servicing fees, and closing costs.
Hard money loans also have a shorter repayment period than traditional loans. The main purpose of these loans is to get a property ready for the market as soon as possible, so lenders expect a quick turnaround.
Why Should You Use a Hard Money Loan?
The costs for hard money loans can seem daunting, but they certainly have their use for certain borrowers who can’t get traditional financing. Hard money loans can be beneficial for their:
Lenders are mainly worried about the collateral, not your financial situation, which often means faster closing than with traditional loans. Lenders do not need to spend as much time going over your loan application, verifying income and employment, or perusing your entire financial history.
Once you have built a relationship with your lender, you can proceed through the process without much conflict or hindrance. Where a normal mortgage can take months to process and close, hard money loans can close within a matter of weeks, so you won’t have to worry about missing out on an investment opportunity.
Hard money loans are generally more flexible than conventional loans mainly because they are offered by private individuals. These private lenders do not have a standard underwriting process. Hard money lenders evaluate each individual deal. This gives borrowers more room to negotiate loan terms, including the repayment schedule and a reduced or eliminated origination fee.
With a hard money loan, you’re not borrowing from a large, faceless company with strict policies. You’re usually borrowing from an actual person who is willing to talk with you and work things out.
Approval & Collateral
For hard money lenders, collateral is the most important factor. That is what will make or break a potential loan, so a previous foreclosure or negative items in your credit report are much less important. While most lenders will ask about your personal finances, many may not even check your credit.
With such low loan-to-value ratios, lenders know that they can quickly sell your property and get all of their money back. Furthermore, while most hard money loans use the property as collateral for the loan, some lenders will allow some leeway. For example, some lenders may allow you to secure your loan using a retirement account, a residential property you own, or other personal asset.
When to Use Hard Money Loans
Even with all of the benefits and convenience of hard money loans, they are not necessarily right for every person or every situation. If you want to purchase a primary residence and you have good credit and income history and don’t mind waiting for lengthy processing times, a conventional loan through a bank should work perfectly fine. Hard money should mainly be used if banks and traditional lenders are not an option or if you have a limited amount of time.
Home investors and fix-and-flip investors are usually the most common applicants for hard money loans. The fast approval means that they can easily get a property with several competing bids. They take a property long enough to fix it up, sell the property, and repay the loan, all within a year. You can potentially use hard money for a property you plan to live in, but you would want to refinance as soon as you can.
Borrowers may also seek hard money loans if they have been rejected for a conventional loan based on issues with their credit or income history. Some banks may deny loans to those who just started a new job because of insufficient income history. Hard money lenders generally will not care about these factors as long as you have enough equity in the property and can repay the loan.
Generally, you should look into a hard money loan if you:
- Want to fix and flip a property
- Need a land loan
- Need a construction loan
- Have any credit issues
- Need to act quickly to purchase a potential property investment
To get connected with the right investors, you have to find those who are willing to lend based on your collateral. Local real estate and real estate investment groups are great sources for finding the names of potential hard money lenders. When you do find potential lenders, talk about your personal needs and build your relationship to get the funds you need.
Del Toro Loan Servicing offers the tools and resources for both borrowers and lenders. Our team can help you find hard money loans to fund your investment projects. Contact us to begin the process today.