By Phillip Miller from Cavalier Estates, March 17, 2021
When trying to get funding for their investments, the first and only option for many property investors is a traditional loan from a bank or other financial institution. But conventional loans are not the only option for financing a real estate investment. It is also possible to fund an investment using what is known as a “hard money” loan.
As your property investment portfolio grows, you will at some point find yourself in a situation where a standard loan doesn’t work for you. In those times, knowing about alternative sources of financing and how to use them can make all the difference to the success of a project. One of the financing options you must become intimately familiar with is hard money loans.
Understanding hard money loans will let you do the types of real estate investing that are not possible with traditional loans. Hard money loans give you the ability to react fast and secure deals that will not wait around while you process a conventional loan. To expand your opportunities as a property investor, you must understand how to use hard money lending.
What is a hard money loan?
A hard money loan is a short-term loan issued by an individual or funding from private investors. They offer alternative financing for investors who need quick cash or investors who cannot obtain loans from conventional lenders.
Hard money loans have more demanding terms than traditional loans, but their qualification criteria are far easier. You can secure hard money loans using real estate. That could be a property you already own or the property you want to buy with the loan money.
Most hard money loans have a term of 12 months, but they can also have an extended duration of 2 – 5 years. Hard money loans mostly require monthly payments of interest only or interest and some principal, with a lump-sum payment at the end of the loan term.
Differences between a hard money loan and traditional loans
Unlike banks and credit unions, hard money lenders base their lending decisions on the property’s value (the collateral) rather than the borrower’s credit rating or income history. As a result, borrowers with poor credit or insufficient income history can still get a hard money loan.
Hard money loans are always short-term. Most hard money loans are repayable within 6 – 18 months. That is different from the 15 – 30 year repayment period of a conventional loan.
Hard money lenders usually don’t invest in owner-occupied properties; the loans are for real estate investors. The reason is residential properties are subject to rules and regulations that make it difficult for hard money lenders to invest in them.
Hard money lenders don’t sell loans to Freddie Mac or Fannie Mae. They use their funds or money from private investors.
Hard money lenders do not have preset lending criteria. The terms they ask from a borrower depend on the details of the borrower’s loan application.
Pros and cons of hard money loans
- Speed: It takes a day or two to complete the application process for a hard money loan. The application can get approval on the same day, and you can receive the funds within a week. A traditional loan, on the other hand, can take 30 – 45 days. That is why hard money is a great financing option for house flippers and estate developers.
- Collateral: Since the property serves as security for the loan, it makes the process of getting a hard money loan more straightforward. In addition to the property, you can secure a hard money loan with a retirement account or other assets.
- Flexible terms: Since there are no middlemen, borrowers can directly negotiate the terms of a hard money loan with the lender. That allows investors to get the loan terms that suit them the most.
- Convenience: Getting a hard money loan does not require a borrower to produce proof of income, tax returns, or bank statements. The process is less burdensome for borrowers.
- Ability to fund multiple projects: Since hard money lenders are only concerned with the value of the property that serves as collateral, investors can finance more than one project at a time. That is not possible with a traditional lender.
- Gives investors an edge: With access to hard money lending, an investor can outcompete real estate investors who don’t use hard money loans.
- Cost: Hard money loans are costlier than traditional loans. The interest rate is usually 10% – 15%, which is 10% points higher than a regular loan.
- Short repayment period: The shorter repayment schedule for a hard money loan leaves investors with little to no margin for error.
When should you use a hard money loan?
As long as you meet the qualification criteria for a traditional loan and have enough time to go through the loan approval process, you have no reason to use a hard money loan.
Hard money loans are obtainable in the following situations:
- When flipping homes
- When you have poor credit
- And when a deal demands that you act quickly