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, also called bridge loans, are short-term loans that are commonly used by investors, such as house flippers or developers who renovate properties to sell. They are usually funded by private lenders or investor groups rather than banks.
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.
Borrowers with good credit may find that a conventional lender offers the lowest interest rates on mortgages. Borrowers with assets but poor credit are likely to find more affordable loans with a hard money lender. Hard money lenders are primarily concerned with the collateral used to secure the loan, which is often the property that the funds are used to purchase. However, a different property or a financial account could also be used as collateral, if the lender agrees.
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 mortgages, which can sometimes take months to process, hard money loans can be available in just weeks, or even 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.
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, 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.
Advantages of hard money loans
- 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.
Flexible loan terms
If you have assets or property to use as collateral, it doesn’t much matter what your credit history looks like when it comes to these loans. Hard money lenders tend to be flexible when it comes to negotiating loan terms. They don’t have to adhere to cumbersome regulations that conventional mortgage lenders are subject to..
Compared with the glacial pace of traditional mortgage underwriting, hard money loans can be processed in just days to weeks. For real estate investors, speed can sometimes make all the difference when it comes to closing a deal — for example, when bidding on a competitive property at auction.
Don’t require strong credit history
You don’t need a good credit score or loads of financial documentation to get a hard money loan. While traditional mortgage underwriting focuses on borrower income and credit history, hard money lenders extend loans on the basis of collateral, such as a house or building. For this reason, hard money lenders need to know the estimated market value of the property after the planned renovations are completed. This estimate is called the “after repair value” or ARV of the property.
Drawbacks of hard money loans
- The interest rates are much higher than conventional loans.
- The processing fees are costly, up to three points or more.
- There are usually prepayment 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.
Hard money loans are costly compared with traditional loans. Interest rates can range from two to 10 percentage points higher than for conventional mortgages, so these loans are best used for short-term projects. The upfront fees are expensive. They can be as high as three to five points or more, and closing costs are likely to be steep as well.
Conservative loan-to-value ratios
You’ll need significant assets to qualify for a hard money loan. Hard money lenders typically require loan-to-value (LTV) ratios of around 50 percent to 70 percent. That’s considerably more conservative than for conventional mortgages. By comparison, Fannie Mae guidelines specify LTVs from 75 percent to as high as 97 percent.
Best for short-term funding
With typical repayment periods of one to five years, hard money loans are most suitable for short-term projects, such as when an investor expects to quickly fix up and sell a property for a profit. Some hard money loans are structured as interest only loans, followed by a large balloon payment.
Some investors use a hard money loan to fund renovations on a property, then quickly refinance to a conventional mortgage with a lower interest rate.
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 the monthly payments and any scheduled balloon payment.
How to find a hard money lender
Finding hard money lenders in your area can take a bit of work. Your first step should be to ask local real estate agents for referrals. You can also check with any real estate investment groups in your town, who are likely to have relationships with such lenders.
Next, try national online lenders that provide loans for residential or commercial investments. Research the lenders before contacting them to determine their specialization. Some lenders, like LendingHome, Lima One Capital, and Patch of Land, focus on investors who are renovating and flipping properties. Visio Lending is another hard money lender covering rental property investments. Finance of America Commercial and Delancey Street offer financing for commercial properties.