Hard money loans are a way of borrowing funds short-term. They’re especially popular with real estate investors, but they could be a good tool for borrowers with assets in their portfolio but poorer credit. Here’s what you need to know.
What is hard money loan?
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, 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
They’re both 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 instead by the borrower’s credit.
Why get a hard money loan?
Borrowers 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.
What is a hard money lender?
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.
Who should use a hard money loan?
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.
“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 foreclosure.
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.
Special considerations for 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 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.
Pros and cons of hard money loans
Advantages of hard money loans
- Accessible to people who have equity but are not eligible for traditional loans
- Money is available quickly, usually within two days
- 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 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 on the basis of collateral, such as a house or building.
For this reason, hard money lenders do 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
- Interest rates are much higher than those of conventional loans
- Processing fees are costly, up to three points or more
- Usually prepayment penalty for paying off the loan early
- Large down payment requirement, usually 30 percent or more
Hard money loans are costly compared to 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 also expensive, and can be 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 may be charged a prepayment penalty if you pay your loan sooner than the term dictates, which can add to costs.
Conservative loan-to-value 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 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 a local real estate agent 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, and Finance of America Commercial and Delancey Street offer financing for commercial properties.