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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, but poorer credit. Here’s what you need to know.
- Hard money loans, also known as bridge loans, are secured, short-term loans often used to finance a home purchase.
- Real estate investors commonly rely on hard money loans to manage multiple flip projects. They're geared toward borrowers who need to bypass a credit check or some of the other stricter underwriting requirements of a regular mortgage.
- A hard money loan can work if you need cash quickly, but it comes at a higher interest rate compared to other types of financing.
- You won't find hard money loans at a typical bank. Instead, you might need to go to a payday lender or through your Realtor for a recommendation.
- If a hard money loan feels like too much of a risk, you might be better off with owner financing or another form of alternative financing.
What is a hard money loan?
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 might also be a solution if facing foreclosure.
Hard money loans are usually funded by private lenders or investor groups, rather than banks, and use 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 value of the property and comes with a short repayment term, usually less than a year.
For this reason, they’re often sought out by those who buy homes with the intent to fix them up and offload them quickly. This presents an opportunity for the hard money lender, who (in theory) can count on getting repaid within a relatively short time frame.
Hard money loans vs. traditional mortgages
Hard money loans are different from typical mortgages for several reasons. For one, they tend to be faster to apply for, and close quicker, too. Additionally, the repayment term on a hard money loan is much shorter than the more popular 15 years or 30 years for a mortgage.
“They are underwritten differently and have different requirements, and they are usually short-term, with some lasting as little as six to 18 months,” says Jeff Shipwash, CEO of Shipwash Properties LLC, a home-flipping company in Knoxville, Tennessee, that often utilizes hard money lenders for its projects.
The interest rates charged for hard money loans are also usually much higher than a traditional mortgage.
“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.
Lastly, hard money lenders require a down payment, often one that’s greater from a percentage basis than a traditional mortgage — think 20 percent at minimum, or 30 percent or more. A conforming conventional loan can be had for just 3 percent down.
Hard money loans are also different from so-called soft money loans:
- Hard money loans are usually secured by physical assets like property and its assessed value in the form of equity. “Hard money loans are generally non-recourse,” says Mills Menser, CEO and founder of Diamond Banc, headquartered in Columbia, Missouri. That means if the borrower doesn’t repay the loan, the outcome is simply forfeiting the pledged asset.”
- Soft money loans are backed by the borrower’s credit. They “obligate the borrower to repay the total sum of the amount borrowed, and considerations such as creditworthiness and repayment ability are generally heavily weighted,” says Menser. “Also, with soft money loans, the borrower is responsible for the debt in the event of default, until the debt is satisfied.”
Who is a hard money loan best for?
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,” says Aragon. “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, too, proving income can sometimes be challenging.
“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.
Working with hard money lenders
Expect to encounter higher interest rates and shorter loan terms when working with a hard money lender. You might also run into loan features like balloon or interest-only payments.
Know, too, that a hard money lender is similar to a payday lender 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,” says Ailion.
How to get a hard money loan
There are many ways to find hard money lenders, including a route as simple as an online search. If you know people who work in real estate in your area, such as a real estate agent, settlement agent or closing attorney, they might have a few hard money lenders in their network they can refer you to.
“Title offices record loans for hard money lenders regularly and can give you referrals to hard money lenders who lend in your area,” says Robert Taylor, a full-time real estate investor in Sacramento.
If you have a connection, you could also try checking with real estate investment groups in your town. Additionally, you could explore national online lenders that provide loans for residential or commercial investments.
Some lenders, like Kiavi, Lima One Capital and Patch of Land, work with investors 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.
Pros and cons of hard money loans
Pros of hard money loans
- 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.
- 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 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
- Higher cost – 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.
FAQ about hard money lending
Hard money loan interest rates might be in the double-digits — far higher than the ones 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.
“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.
Even if your credit is lacking, you don’t have to take out a hard money loan. There are some traditional mortgage lenders that have experience working with investors or borrowers with unique financial circumstances, and even some that offer bridge loans in addition to the typical 30-year loan.
You could also try owner financing, or to raise the capital yourself.
“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.”
Hard money loans are risky. This is primarily because they come with higher interest rates and shorter repayment terms, and there’s limited regulation around them compared to typical mortgages. This means that you, as the borrower, would have very little protection or options if you were to need help repaying the loan. Likewise, if you use a hard money loan to flip a home, then can’t sell it, you’d be on the hook for a potentially large sum, and could even lose the property.