If you’re interested in real estate or looking to grow as an entrepreneur, a hard money loan could be a way to get the cash you need (and fast, too). Keep reading to learn exactly what the process entails, plus the pros and cons.
What is a hard money loan?
A hard money loan is a loan secured by real property. It’s a way borrowers can take out a loan without using a traditional mortgage lender.
The loan either comes from an individual or investor who lends you the money based on the value of the property you’re using as collateral. Oftentimes, this type of loan is used as a last resort or considered a short-term bridge loan, meaning the loan lasts until the borrower secures enough permanent financing.
How hard money loans work
The terms of a hard money loan are all based on the value of the property being used as collateral. Your credit history and score do not have any effect on your chances as a borrower.
This is largely because traditional lenders, like a bank, do not make hard money loans. To get one, you’ll work with a private individual or company that would find value in giving you a loan.
For example, this loan is commonly issued to property flippers who plan to pay off the high loan relatively quickly.
Pros and cons of hard money loans
Hard money loans have very high interest rates, so they can be a very expensive option. There are, however, pros to getting one.
Here’s what to know:
- Easy approval process. The hard money loan approval process tends to be much quicker than applying at other traditional institutions.
Lenders are private companies or individuals who care more about the value of your collateral than your financial situation, so they can make decisions quicker. They don’t spend as much time verifying income, bank statements, etc., and if you’ve worked with the lender before, the process can be even quicker.
- They’re relatively flexible. Most lenders don’t follow a standard loan process when it comes to hard money loans.
Each borrower is evaluated on an individual basis, so your financial situation will determine a repayment schedule.
- Collateral is the name of the game. This is the most important factor for lenders, so if you’re investing in a property that’s worth a lot, the lender will give as much as it’s worth.
Sometimes, hard loan investors aren’t concerned with repayment because there could even be an opportunity for them to resell the property if the borrower defaults.
- It’s very expensive. Because the actual property is the only protection against default, hard money loans have lower Loan-to-Value (LTV) ratios than other traditional loans.
For example, the LTV for a hard money loan is usually around 50% to 70% vs. a typical mortgage that has a 80% LTV. Plus, the interest rates can be very high–expect to pay rates in the double-digits.
- More pressure to succeed. Because these loans are more expensive, it’s very important the project you’re working on (i.e. the property being used as collateral) increases in value – or at least you break even.
How to get a hard money loan
To get a hard money loan, you’ll need to connect with investors looking for new properties. Start by researching companies and individuals in your area that lend money based on collateral. Local real estate agents or investor groups can be great resources for this.
Then reach out and inform them of your goals and needs so you can start a working relationship and apply for the money once you’re ready.
A traditional lender, such as a bank or credit union, is always interested in: proof you can pay them back, your credit history, and your available income.
Lenders who issue hard money loans are not.
It’s fairly easy to be approved by a hard money lender because they lend money based on collateral and they aren’t necessarily interested in your ability to repay. They know that if anything goes wrong, they can get their money back by taking your collateral and selling it.
This type of loan is usually considered a short-term loan and lasts from one to five years. It wouldn’t be financially wise to keep them any longer because of the high interest rates.
Tips for paying off a hard money loan
If you want to get into the world of real estate, hard money loans are a great option. But, because this type of loan is so much shorter than traditional loans and has a higher interest rate, it’s important to have a strategy to pay it off. Here are some things to consider:
- Sell the property being used as collateral. Most times, the main reason someone would get a hard money loan is to finance their property flipping project.
The goal is to purchase a property, use it as collateral, improve the property, then sell it for a profit. This option allows you to plan and invest in the best way to maximise profits while improving the property.
- Refinance with the lender. If your plan wasn’t to flip a piece of property but to rent it out, refinancing may be your best bet.
This strategy gives you a longer-term plan for income rather than one lump sum. Discuss this with your lender and see what they’re open to.
- Secure a traditional mortgage. If you want to stay in the property you purchased with your hard money loan, you should consider a mortgage.
You can use your hard money loan to build up your credit or pay off other debts, thus increasing your chances of being approved for a mortgage from a traditional financial institution.
What happens if you default on a hard money loan?
If you default on a hard money loan, the property used as collateral for the loan will be used as the asset to pay off the loan.
Your lender will foreclose the property, which could require you to sign a Deed of Trust, Promissory Note, or go to court to settle depending on where you live.
Do hard money loans require an appraisal?
Yes! Because the value of the property is the most important factor in receiving a hard money loan, the approval process includes an appraisal to determine what that value is.
Do hard money loans show up on credit reports?
Most hard money loans do not show up on your credit report. But because this isn’t always the case and can vary by lender, it’s important to have this conversation with whoever you’re borrowing the money from.