Hard money lending: Guide to hard money loans

What is a hard money loan?

Hard money loans, also called bridge loans, are short-term loans commonly used by real estate investors, such as house flippers or developers who renovate properties to sell. They can also be a good tool for borrowers with assets but poorer credit and could be one solution if you’re facing foreclosure.

Hard money loans are usually funded by private lenders or investor groups rather than banks, using equity or real property as collateral.

How does a hard money loan work?

Hard money loans are secured by the property they’re tied to instead of the borrower’s credit and financial profile. The loan is typically based on the property’s value and comes with a short repayment term, usually less than a year.

Some hard money loans are structured as interest-only loans, followed by a large balloon payment. This makes them riskier than other kinds of financing.

Hard money loans vs. traditional mortgages

Hard money loans are different from typical mortgages for several reasons:

• Applying for and closing on a hard money loan is often much faster than with a traditional mortgage — and the repayment terms are much shorter than the usual 15- or 30-year timelines. You’ll usually repay a hard money loan within six or 12 months, though some terms may be longer.
• Hard money loan interest rates tend to be much higher than those for a traditional mortgage.
• A hard money lender will require a down payment, often one much higher than a traditional mortgage — think at least 20 percent, if not 30 percent or more. A conforming conventional loan can be had for just three percent down.
• Unlike a traditional mortgage, which is backed by the borrower’s creditworthiness, hard money loans are secured by the physical property and its assessed value in the form of equity. If you default on a hard money loan, you’ll generally lose the asset you put down as collateral, rather than being able to work out a repayment plan.

Pros and cons of hard money loans

Before you decide to work with a hard money lender, consider the pros and cons of this financing option:

Pros of hard money loans

• Flexible loan terms: Hard money lenders tend to be flexible when negotiating loan terms. They’re not subject to the same regulations as conventional mortgage lenders.
• Speedy funds: Compared with the glacial pace of traditional mortgage underwriting, hard money loans can be processed in just days. 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 a strong credit history: 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. Hard money lenders care more about the estimated market value of the property after the planned renovations are completed and less about your financial history.

Cons of hard money loans

• Higher cost: Hard money loans are costly compared to traditional loans. The interest rates can be several percentage points higher than rates for conventional mortgages, and the upfront fees are also much more expensive. In addition, you could be charged a prepayment penalty if you pay your loan sooner than the term dictates.
• Large down payments: You’ll need to put down much more of the purchase price to qualify for a hard money loan than you would for a conventional mortgage. While you can get a conventional mortgage for as little as three percent down, hard money lenders typically require closer to 20 or 30 percent down, if not more.
• Hard money lending regulations: Hard money lenders are similar to payday lenders, in that they’re subject to little oversight or regulation.

Who is a hard money loan best for?

The types of borrowers who tend to get hard money loans include property flippers, borrowers who cannot qualify for traditional loans, and less commonly, homeowners with substantial equity in their homes facing foreclosure.

Property flippers

People who buy properties to renovate and resell for a profit, known as property flippers, often choose hard money financing, says Julie Aragon, a Los Angeles-based mortgage expert with Arbor Financial Group.

“Property flippers turn to hard money loans because they can lock in funding almost overnight,” Aragon says. “That speed gives them a serious edge over buyers stuck waiting for a traditional lender.”

Borrowers who don’t qualify for traditional loans

There are many reasons why some borrowers don’t qualify for a 30-year fixed-rate mortgage from a bank, such as a recent divorce that affected their credit score or the inability to document their income, an issue for some business owners and freelance workers.

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

Homeowners facing foreclosure with substantial equity in their home

Although this isn’t a common scenario, 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, should the loan go into default, they can sell the house, pay off the first mortgage and still earn a profit from the sale.

How to get a hard money loan

1. Find a reputable hard money lender

While you can probably name many traditional mortgage lenders, it can be more difficult to find a hard money lender. Apart from searching online, you can get a referral. Real estate professionals, including real estate agents, settlement agents, title officers or real estate attorneys may all be able to refer you to a hard money lender.

2. Meet certain requirements

To get a hard money loan, you must meet certain requirements. These vary by lender, but some of the most common criteria include:

• Meeting the lender’s minimum credit score and debt-to-income (DTI) ratio
• Being able to make a large down payment, at least 20 percent of the loan amount
• Providing income statements

3. Gather documentation

Like preparing for any loan application, it’s important to gather your documentation, including your identification, income information, tax statements, bank statements and other financial statements.

4. Compare lenders and apply

First, compare offers from multiple lenders. Look at the interest rates they charge and any associated fees. You can do this by comparing the interest rate versus the APR. Talk to your chosen lender and submit an application, answering any questions it has and providing the required documents.

Alternatives to hard money loans

There are a few alternatives to a hard money loan, including:

• Private money loan: These, potentially informal, arrangements are less regulated than hard money loans and may have very flexible terms.
• HomeStyle loan through Fannie Mae: These funds can be used for renovations and repairs, but you must meet eligibility requirements, like having a credit score of at least 620.
• Cash-out refinance: If you have enough equity in your home, you could apply for a cash-out refinance and use the funds remaining after you’ve paid off your mortgage instead of a hard money loan. This will likely increase your monthly mortgage payment.
• Home equity line of credit (HELOC) or a home equity loan: These mortgage loan products act as a second lien on your home. You can use a HELOC or home equity loan if you have enough equity built up in your home and meet eligibility requirements.

FAQ

• What are hard money loan rates?

  Hard money loan interest rates might be in the double-digits — far higher than the rates for 30-year fixed-rate mortgages. The rates and fees are typically determined by how much financing you require and the value of the deal to the lender.

• Are hard money loans risky?

  Hard money loans are risky. This is primarily because they come with higher interest rates and shorter repayment terms, and they have limited regulations compared to typical mortgages. This means that you, as the borrower, would have very little protection if you needed help repaying the loan. Likewise, if you use a hard money loan to flip a home and can’t sell it, you’d be on the hook for a potentially large sum and could even lose the property.