In the world of real estate, loans are a permanent fixture. Ideally, people can buy or build their dream home without the need for a loan. Realistically, navigating the financial aspect of building or buying a home is a challenge, especially if you need the funds immediately or do not qualify for other forms of financing.
Here’s where hard money loans come in handy.
When you refuse to or can’t work with a traditional lender, a hard money loan offers you another shot at financing your home. Intended for real estate investors and home flippers, this short-term loan is a private lender-sponsored loan backed by a tangible asset (e.g. real estate) instead of your credit.
Like other loans, however, hard money loans can be risky and expensive, especially if you’re either new to flipping or have no idea about hard money loans.
So before you go looking for hard money lenders in your area, it’s important to know what you’re dealing with.
What are Hard Money Loans?
Also called a “rehab loan,” a hard money loan is a type of loan that secures funds with real property instead of a borrower’s creditworthiness. This loan often lasts for one to three years and is used to secure money quickly.
Like the short-term bridge loan, hard money loans are often used in real estate transactions when the lender is a company or an individual since banks do not offer them. House flippers often use this type of loan to secure funding for home renovations.
Other short-term and conventional loans offer the same funding as hard money loans (e.g. fix-and-flip loans). But these loans come with a rigorous underwriting process that takes weeks or months before you receive approval. With hard money loans, you can get approved in a day or a week — if you qualify.
Another “perk” of hard money loan is its lenders aren’t interested in your credit history and income, which commonly hinder many people from getting a loan.
With a hard money loan, all of your loans are based on the residential property, which the lender uses as collateral.
How Do Hard Money Loans Work?
With a hard money loan, you can borrow funding for real estate without using traditional mortgage lenders. Instead, the funds come from investors or individuals who lend money based on the real estate property that you’re using as collateral.
Although your creditworthiness doesn’t play a role in qualifying for a loan, hard money lenders still consider several factors before they approve your application. These factors include debt-to-income (DTI) ratio, home equity and loan-to-value (LTV) ratio. Once you pass all three, you can get your loan approved as soon as possible.
However, the application process becomes more challenging if you have a high debt-to-income ratio or a low credit score, the latter being an income source that lenders can’t easily verify. Also, if you are suddenly unable to repay the loan, hard money lenders get their money back by taking the collateral and selling it.
What is the Interest Rate for Hard Money Loans?
While hard money loans are a quick way to get funding for a real estate purchase, you wouldn’t want to keep these loans for a prolonged period due to its high-interest rates. As of 2020, the average interest for a hard money loan stands at 11.25 percent. In the United States, the rates varied from 7.5 percent to 15 percent, depending on which state you live in.
Do Hard Money Loans Require Down Payment?
In most cases, yes.
How much do you have to put down on a hard money loan? Private hard money lenders often require 20 to 30 percent of the loan amount. However, if you’re an experienced house flipper, your hard money lender may require a 10 percent down payment from you.
Lenders calculate the down payment amount based on your credit score, your prior experience and the valuation of the property the loan is for.
Do You Need a Hard Money Loan?
Hard money loans are appropriate if you are unable to get funding or if you need quick funds for a real estate purchase. After all, hard money lenders do not spend much time examining your application (although they still want to be sure that you can repay them). For instance, they may not spend much time verifying the source of your income.
Once you’ve established a relationship with your hard money lender, the application process will move quickly, and you can close deals that other loans can’t. This makes a hard money loan a helpful tool when navigating hot markets with properties that get multiple offers.
Are Hard Money Lenders Worth It? The Pros and Cons
Similar to other loans, hard money loans aren’t perfect. These loans have their sets of pros and cons, so before you sign the dotted line, it’s important to consider the benefits and the drawbacks.
Benefits of Hard Money Loans
- Good credit isn’t always a requirement. Hard money loans are asset-based loans, which means lenders focus on the value of the property. They vet your rehab plan to ensure it’s realistic for the funding you’re requesting. As mentioned above, hard money lenders do not do credit checks or background checks on applicants. Also, each deal is individualized and not subject to the underwriting process.
- Short-term loans. You can take out hard money loans for a term between six to 18 months (or even longer). For example, house flippers only need a loan for the renovation period. Depending on your hard money lender, you can extend a loan’s life if your project takes longer than expected. Still, check the rules that apply to the extension before signing a contract.
- Quick-close loans. Conventional loans take weeks or months to close since banks and financial institutions study your financial health, which includes your employment status, income and credit history, as well as your current assets and debts. With a hard money loan, you can close the loan in a week — or even a day.
Drawbacks of Hard Money Loans
- High-interest rates. Hard money loans are riskier and more expensive. Traditional loans offer more competitive rates due to the rigorous underwriting process. On the other hand, hard money loans have an interest rate range of eight to 12 percent, depending on the loan’s terms.
- Hidden costs. You may put down a bit of your money to acquire the hard money loan. Apart from the interest rate and the down payment, you must also shoulder the fees required by your hard money lender — typically, an appraisal fee, organization fee and documentation fee (for the paperwork). You should also pay for the builder’s risk insurance, which protects the property and materials covered in construction.
- You can lose your property. The reason hard money lenders aren’t too focused on your credit is that your home serves as the collateral. If you stop paying your loan, hard money lenders can repossess your property and sell it to make up for their loss. So make sure to pay your dues and finish all the home improvement projects within the set period.
Are There Alternatives to Hard Money Loans?
If you’re hesitant to risk your money jar with hard money loans, you have other options. These options may have a stricter approval process, but they come with lower interest rates and upfront costs.
Insured by the Federal Housing Administration (FHA), FHA loans make it easier for borrowers to qualify for loans. At the same time, they benefit from lower interest rates. This loan is ideal for people who don’t meet the credit criteria of traditional mortgage lenders.
VA loans are affordable loan options available for qualified service members, veterans and their spouses. These loans are supported by the Department of Veterans Affairs and have less expensive upfront costs and a less strict approval process.
Unlike traditional loans, the VA’s credit score requirements are lower. You may also avoid a down payment!
The Bottom Line
Hard money loans are ideal for people who don’t qualify for traditional financing options or if they need immediate funds for their homes. Before you search for “hard money loans near me,” understand the pros and cons of a hard money loan to see if you are up for it. If you have questions, get in touch with a loan expert first to make an informed decision.