Hard Money Loan Definition
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What is a Hard Money Loan?
A hard money loan is backed by a “hard” asset such as real estate. Conventional lenders (banks and credit unions) consider the borrower’s income, net worth, and credit score in lending decisions, but hard money lenders focus almost exclusively on the value of the asset used as collateral.
Hard money loans are similar to a short-term bridge loan; they are commonly used to finance fix-and-flips or fix-and-rents where the borrower intends to refinance the property once renovations are complete.
Hard money lenders are usually individuals or private lending companies. Traditional banks are not generally in the business of hard money loans.
Features of a Hard Money Loan
These features differentiate hard money loans from other traditional forms of financing:
- Hard money loans as asset-backed, relying on the value of the collateral. Most lenders use the after repair value (ARV) to determine the loan amount.
- Hard money loans have higher interest rates, typically 4-10% above mortgage market rates. Borrowers usually pay between 2 and 5 points, depending on the loan-to-value ratio and the borrower’s track record.
- Most hard money loans have terms of between 6 and 24 months; they are not amortized like traditional mortgage loans.
- Hard money loans are not generally used for owner-occupied properties.
Funding is typically handled with one large disbursement to acquire the property. The remaining loan amount is drawn down by the investor as needed to complete renovations and repairs.
When to Use a Hard Money Loan
The approval and funding process for a hard money loan is much quicker than for traditional mortgages. Access to fast funding gives investors an edge on time-sensitive deals, and this is a core component of why real estate investors utilize hard money loans.
Usually, investors turn to hard money loans to:
- Fund a rehab project where the plan is to quickly flip the property and repay the loan.
- Bridge the financing gap until the investor can get traditional financing, such as a construction loan for a multi-family investment property or a rehab project on a buy-and-hold rental.
- Purchase land for subdivision or development.
Investors can usually find hard money loans for most types of projects—residential, multi-family, commercial, land—although lenders may specialize in one particular niche. For example, one hard money lender may specialize only in loans for residential fix-and-flips.
Qualifying for a Hard Money Loan
With hard money lenders, the quality of the deal is the primary consideration. In other words, the lender considers the price of the property, the itemized list of repairs and renovations, the time frame to repayment, and the ARV or LTV depending on the project being financed. The borrower’s experience with the type of project is also a factor.
While the asset is the main focus, some lenders will also consider the borrower’s credit history and track record on previous real estate projects. This is especially true with private lending companies; which tend to have a more structured approval process.
Pros and Cons of Hard Money Loans
While hard money loans serve an essential need in real estate financing, there are definite upsides and downsides to this type of funding.
- Leverage. Investors can get money to enter a deal without risking any of their own capital.
- Speed. The approval and funding process can be accomplished in a matter of days.
- Flexibility: Hard money lenders are not subject to the regulatory and underwriting standards that apply to banks and conventional lenders.
- Cost: Hard money loans are more expensive than traditional loans. Origination fees, application fees, higher interest rates, and even builders risk insurance add substantially to the cost of the loan.
- Risk: The lender holds the property as collateral, which means that the investor walks away with nothing if they cannot complete the project and repay the loan on time.
- Short-term: With terms of 12 months or less, the investor does not have a lot of wiggle-room for unforeseen circumstances and delays.
How to Apply for a Hard Money Loan
The first step is to find a reputable hard money lender. Google is a good place to start, as is the local real estate investor association (REIA). Real estate agents may also have connections to hard money lenders. LinkedIn is another resource for finding private hard money lenders.
Look for a lender with extensive experience in the type of project being funded and compare interest rates and fees. Check maximum loan amounts to be sure the lender can fully fund the project.
Borrowers should be prepared to prove experience and credentials; a portfolio of previous projects is a good idea. The pitch should be well-organized and detailed, which should include an itemized list of repairs and renovations and documents to support ARV. Most hard money lenders require a builders risk policy, which has more specific coverage than a general property and casualty policy required by mortgage lenders.
Hard money loans can be a powerful tool for investors who want to scale their business, but they are not without risk. Investors should check online reviews and word-of-mouth recommendations before choosing a hard money lender.
- Ceizyk, D. (2019.) What are Hard Money Loans and How Do They Work? LendingTree. Retrieved from https://www.lendingtree.com/home/mortgage/hard-money-loans/
- Sweren, A. (2019.) How Do Hard Money Loans Work? Nav. Retrieved from https://www.nav.com/blog/how-do-hard-money-loans-work-343006/
- Sbeih, A. (2016.) Six Tips for Choosing a Hard Money Lender. Socotra Capital. Retrieved from https://socotracapital.com/six-tips-choosing-hard-money-lender/