Hard money loans are a way of borrowing funds over the short term. They’re especially popular with real estate investors, but they can also be a good tool for borrowers with assets in their portfolio but poorer credit. Here’s what you need to know.
What is a hard money loan?
Hard money loan definition
Hard money loans, also called bridge loans, are short-term loans 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, and use equity or real property as collateral. Some hard money loans are structured as interest-only loans, followed by a large balloon payment.
Hard money vs. soft money
Hard money loans and soft money loans both offer ways to borrow, but the loans they secure are backed by different things. Hard money is usually secured by physical assets like property and its assessed value in the form of equity. Soft money is backed by the borrower’s credit.
“Hard money loans are generally solely secured by the underlying asset as opposed to the borrower’s repayment ability,” explains Mills Menser, CEO and founder of Diamond Banc, headquartered in Columbia, Missouri. “Hard money loans are generally non-recourse. That means if the borrower doesn’t repay the loan, the outcome is simply forfeiting the pledged asset.”
Soft money loans, on the other hand, “obligate the borrower to repay the total sum of the amount borrowed, and considerations such as creditworthiness and repayment ability are generally heavily weighted,” adds Menser. “Also, with soft money loans, the borrower is responsible for the debt in the event of default, until the debt is satisfied.”
Hard money loans vs. other loans
“They are underwritten differently and have different requirements, and they are usually short-term, with some lasting as little as six to 18 months,” explains Jeff Shipwash, CEO of Shipwash Properties LLC, a home-flipping company in Knoxville, Tennessee, that often utilizes hard money lenders for its projects.
By contrast, a mortgage or soft money loan can have much longer terms — up to 30 years or longer, for example.
The interest rates charged for hard money loans are also usually much higher than for mortgages, auto loans or other types of financing.
“Also, unlike a traditional mortgage, the value in a hard money loan deal is factored into the underwriting much more than the borrower’s credit score,” says Shipwash.
Hard money lenders
The term “hard money lender” is used to describe the entity outside of a traditional bank or credit union that lends to an individual or business. A hard money lender is similar to payday lenders offering personal loans or title pawn lenders, without much oversight or regulation to adhere to, says Bruce Ailion, a real estate attorney and Realtor in Atlanta.
“Lenders can charge what they want for the risk they take in making a loan,” Ailion says.
Who should use a hard money loan?
Borrowers typically pursue a hard money loan because they either don’t qualify for a conventional loan or 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.
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.
Others use a hard money loan to fund renovations on a property, then refinance to a conventional mortgage with a lower interest rate.
The 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 with Arbor Financial Group.
“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, 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, some homeowners have a lot of equity in their homes but are at risk of foreclosure. Hard money lenders would consider lending in this situation 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.
Hard money loan rates
Hard money loan rates can fall between 7 percent and 15 percent, but can often be higher, according to Menser. Compare that to a 30-year fixed-rate mortgage, which has averaged in the 3 percent range in 2021, according to Bankrate’s survey of mortgage lenders.
“Some states have usury laws that prevent a hard money loan interest rate from going beyond a certain threshold,” Ailion says. “I’ve seen hard money loan rates as low as 8 percent and as high as 30 percent in my area.”
Shipwash adds that rates and fees are typically determined by how much financing you require and the value of the deal to the lender.
“For example, if you are buying a home to flip at 40 percent of its after-repair value, a hard money lender would give you a better rate versus someone seeking to flip at a 70 percent after-repair value,” says Shipwash.
Do hard money lenders require a down payment?
Hard money lenders require a down payment, often one that’s greater from a percentage basis than soft money loans, Menser says.
“Most require a minimum of 20 percent, while others want to see 30 percent or more. Again, they are looking at the value of the real estate as the primary means of repayment,” Ailion explains. “If you don’t repay, they take the property or finance asset and sell it to satisfy the debt.”
Pros of hard money loans
- Accessible to borrowers who have equity but aren’t eligible for traditional loans
- Money can be available quickly, usually within two days
- Usually don’t 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 a hard money loan. Hard money lenders tend to be flexible when it comes to negotiating loan terms; they don’t have to adhere to the same 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 based on collateral, such as a house or building. For this reason, hard money lenders need to know the estimated market value (after-repair value) of the property after the planned renovations are completed.
Cons of hard money loans
- Interest rates much higher compared to conventional mortgages
- Processing fees are costly, up to three points or more
- Usually comes with prepayment penalty
- Large down payment, usually 30 percent or more
Hard money loans are costly compared to traditional loans. The interest rates can be several percentage points higher than for conventional mortgages, and the upfront fees are also expensive (as high as three to five points or more). Closing costs are likely to be steep as well, and there is a significant down payment requirement. In addition, you could be charged a prepayment penalty if you pay your loan sooner than the term dictates, which can add to costs.
Conservative loan-to-value (LTV) ratios
You’ll need significant assets to qualify for a hard money loan. Hard money lenders typically require a loan-to-value (LTV) ratio of around 50 percent to 70 percent. That’s considerably more conservative than for conventional mortgages. For instance, Fannie Mae guidelines specify an LTV from 75 percent to as high as 97 percent.
Hard money lending regulations
Hard money lenders are subject to federal and state laws that bar them from lending to those who can’t 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
“The best place to look for hard money lenders is to consult with your real estate agent, your title company or your title attorney,” recommends Robert Taylor, a full-time real estate investor in Sacramento. “Title offices record loans for hard money lenders regularly and can give you referrals to hard money lenders who lend in your area.”
If you have a connection, you could also try checking with real estate investment groups in your town that are likely to have relationships with hard money lenders. Additionally, you could explore national online lenders that provide loans for residential or commercial investments. 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, and Finance of America Commercial and Delancey Street offer financing for commercial properties.
Alternatives to hard money loans
A hard money loan isn’t necessarily your only option, even if you lack good credit.
“Private lenders are easier to find than you think — it could be a real estate investor, a family member or friend who has a considerable amount of cash they can lend,” says Shipwash. “In some cases, individuals can even use their retirement accounts to lend you money and invest in your project.”
If you’re seeking to purchase a property, another option is to pursue financing from the seller.
“In this arrangement, you essentially purchase the asset plus interest from the seller over a prolonged period,” Menser says. “In the event of default, the seller reclaims the asset. Interest rates on owner financing are often the same or less than you could get from a traditional bank.”
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 a traditional mortgage. Also, because these loans are secured by equity or real property, you have to have the assets to back them up and not rely on your credit.
With additional reporting by Erik J. Martin