Hard money loans are loans that are secured by a collateral property. If you own real property such as land or residential or commercial buildings, you may be eligible to receive a hard money loan.
As mortgage lenders and banks are limited by federal regulations and red tape, it is usually individuals and private lenders who lend hard money loans to real estate investors. These have shorter term periods compared to other loans – ranging from a few months to over a year or two. Since they come with higher risks, interest rates on these loans are often higher, compared to business loans or traditional mortgages.
A hard money loan is similar to a bridge loan in that they are often utilized for purchasing properties undergoing distress or foreclosure. For the real estate investor, these loans support upgrades, remodel, and rehab efforts. After some time has elapsed, the borrower then sells the improved property for a price greater than the purchase price paid by him. Hard money loans bridge the period between the sale and the purchase. The funds spent by the borrowing investor are also added to a property’s price, which results in a significant profit being made on successfully flipping the property.
Collateral happens to be vital for hard money loans. Lenders spend less time analyzing the borrower’s credit history, credit scores, and finances compared to traditional lenders. Hard money lenders are more focused on the collateral property’s value as this value determines the maximum loan amount to be extended. This greatly benefits the real estate investor as they can heavily rely on their experience as an investor and the repair property value (ARV).
The borrower’s payments are usually on the lower side, a common feature of hard money loans. These loans typically only require interest payments or a sum that includes interest payments and a fixed percentage of the principal. However, borrowers must understand that hard money loans usually end with a sizeable balloon payment. In case everything has gone as per plan, this balloon payment can be paid off with ease using proceeds from a profit windfall or property sale towards the loan period’s end.
Here are a few advantages and disadvantages of obtaining hard money loans:
Advantages of Hard Money Loans
These loans have multiple advantages compared to loans from traditional banks & other mainstream sources.
Sometimes, it can all come down to how fast you can come up with cash for sealing a deal. Hard money lenders are able to process and release the loan money in mere days. In comparison, a mortgage loan application wouldn’t even have been reviewed in this period.
Hard money lenders are mostly focused on collateral security. They do not spend time evaluating credit worthiness like traditional lenders. Negative marks and low credit scores are hardly a concern for them.
These loans have multiple advantages compared to loans from traditional banks & other mainstream sources.
Sometimes, it can all come down to how fast you can come up with cash for sealing a deal. Hard money lenders are able to process and release the loan money in mere days. In comparison, a mortgage loan application wouldn’t even have been reviewed in this period.
Hard money lenders are mostly focused on collateral security. They do not spend time evaluating credit worthiness like traditional lenders. Negative marks and low credit scores are hardly a concern for them.
Since these loans happen to be backed by a real, tangible property, the property’s value is what determines whether the loan will be approved, and if so, how much money will be lent by them. If there is any default, lenders must have the assurance that property sale proceeds would suffice for paying off the unpaid principal amount of the loan.
For some, the real estate investor’s loan repayment capacity isn’t as important as a few other crucial factors. But lenders have to ensure that borrowers can shell out the required monthly payments. In most cases, these payments will be much lesser than normal loan payments.
Hard money lenders possess more flexibility for evaluating your situation on its own merits while making a decision. Since no 2 borrowers have the same set of circumstances, lenders approach each request with a fresh mindset, unlike bank mortgage applications.
Fewer federal and state laws apply to hard money lenders, which permits them to be flexible. However, as a result of the Dodd-Frank Act, it must be kept in mind that hard money lenders don’t provide loans for applications that use primary residences as their collateral.
Disadvantages of Hard Money Loans
Costs must always be taken in account while analyzing loan options. Hard money loans carry a significant amount of risk for lenders, which results in higher interest rates compared to traditional bank loans. The quick loan processing, smaller monthly payments & short-term periods, which are the primary characteristics of these loans must be considered before a decision is made. However, it may be possible that profits made as a result of this loan would be big enough to justify the additional expense.
The value of the collateral is the most important factor affecting your hard money loan application. Lenders take a more conservative approach to collateral value, compared to traditional banks. Banks consider a variety of factors before making a decision that minimizes their risk.
However, in case of a default, hard money lenders only have the collateral’s market value to salvage their loan principal amount from. If a favorable rate is issued to an investing borrower, that raises the risk borne by the lender.
This thinking is reflected in their maximum loan-to-value ratio. While regular lenders allow around 80% – 100% of the collateral value to be issued in a loan, hard money lenders usually limit this to around 50% – 70%. This provides additional protection to the lenders in case the property value declines during the loan period.
Who Should Opt for Hard Money Loans?
As collateral happens to be a crucial factor for hard money loans, it’s not recommended for people without any property. Businesses that have high potential for turning a major profit and own real property may have use for these loans, especially property flippers.
Real estate flippers purchase properties, improve them, and then sell it off for an amount greater than what they’ve poured into it. Businesses that have to incur costs on materials and labor during a loan period will be benefitted by the lower monthly payments. The balloon payment at the term end can be paid off using property sale proceeds.
Retrofitting old buildings or upgrading equipment is an expensive operation, however, they could help you expand, acquire new clients, or increase output, which can boost revenues. Hard money loans can be helpful if you need quick loan processing for a major business opportunity that needs a decision within a short period.
The collateral value and your situation are the only factors considered by hard money lenders, unlike traditional loan sources, who may reject you for a variety of reasons.
When the pros outweigh the cons, taking a hard money loan may be ideal for your requirements.