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What is a hard money lender?

The term “hard money lender” is used to describe lending outside of traditional banks or credit unions to an individual or a business. Hard money loans are usually funded by an investor or a group of investors.

Hard money borrowers secure their loans through equity rather than creditworthiness. This is why these types of loans are also referred to as equity-based loans. Instead of borrowers submitting financial documents and going through credit checks, they put up a large down payment, which helps offset the lender’s risk.

Hard money loans come with shorter terms (around two to five years), higher interest rates and hefty processing fees.

Why get a hard money loan?

People typically pursue a hard money loan because they either don’t qualify for a conventional loan or they need the money quickly.

Unlike conventional loans, which can take weeks to process, hard money loans can be ready in a couple of days.

Types of borrowers who tend to get hard money loans include:

  • Property flippers.
  • Borrowers who don’t qualify for traditional loans.
  • Homeowners facing foreclosure with substantial equity in their home.

Property flippers

Individuals who buy properties, renovate them and resell them for a profit, known as property flippers, will often get hard money financing, says Julie Aragon, a Los Angeles-based mortgage expert.

“Property flippers like hard money loans because they can get the cash fast,” Aragon says. “This expediency is beneficial when they’re bidding on a property. They will have the advantage over someone who might need a month to close.”

Borrowers who don’t qualify for traditional loans

There are many reasons some borrowers don’t qualify for a traditional loan, such as a 30-year fixed-rate mortgage from a bank. These reasons might include a recent divorce that affected their credit score or the inability to document their income. For business owners, proving income can sometimes be challenging, which might make it impossible to secure a traditional loan, Aragon says.

“Self-employed people who write everything off might be able to afford a mortgage, but their taxes don’t reflect that,” Aragon says. “For them, hard money loans are their only option.”

Homeowners facing foreclosure with substantial equity in their home

Although this group is a less common borrower type than the other groups, there are people who have a lot of equity in their home but are at risk of getting foreclosed upon.

Hard money lenders would consider lending to these people if they can be assured that, if the loan goes into default, they can sell the house, pay off the first mortgage and still earn a profit from the sale.

Pros and cons of hard money loans

Depending on your situation, a hard money loan can be a helpful tool or it can be a costly mistake. Most experts agree that hard money loans are a short-term solution, not a replacement for traditional mortgages.

Pros

  • Accessible to people who have equity but are not eligible for traditional loans.
  • The money is available quickly, usually within two days.
  • Hard money lenders usually do not require credit checks or financial disclosures.

Cons

  • The interest rates are much higher than conventional loans.
  • The processing fees are costly, up to three points or more.
  • There are usually pre-payment penalties for paying off the loan early.
  • The down payment requirement is large, usually 30 percent or more of the total value of the loan.

Regulations for hard money lending

Hard money lenders are subject to federal and state laws, which bar them from lending to people who cannot repay the loan. By law, hard money lenders have to establish that a borrower has the means to make both the monthly payments and any scheduled balloon payment.