Hard Money Loans: The Essentials

What Is a Hard Money Loan?

Person holding bunch of money.

Hard money loans are loans that come from an individual or firm rather than a financial institution like a bank. The most common application for hard money loans is the financing of real estate transactions. Hard money loans are short-term loans for commercial or investment properties that are provided not by banks or other government agencies but by private individuals or businesses in exchange for a lien on the borrower’s property or some other form of collateral.

A hard money loan, like a conventional mortgage, is a secured loan backed by the value of the underlying asset. When discussing the value of the loan, the “hard” element of “hard money” refers to the physical object that is being utilized as collateral. When a borrower fails to repay a secured loan, the lender can seize the collateral and sell it to recoup any losses.

Hard money loans, as opposed to conventional mortgages or other secured loans, have a quicker and, in most cases, less stringent approval process, making them an excellent choice when time is of the essence.

How a Hard Money Loan Works

As mentioned above, for a hard money loan the borrower’s creditworthiness is not taken into consideration when determining the terms of a hard money loan; rather, the terms are determined primarily by the value of the property that will be used as collateral. Hard money lenders are typically private individuals or companies who find value in this kind of potentially risky undertaking. This is because traditional lenders, such as banks, do not issue hard money loans.

Because the lender is taking on a greater level of risk by providing the funding, the interest rate that the borrower pays on a hard money loan is often higher than the interest rate paid on financing through banks or otherwise. However, the extra expense is a necessary trade-off in exchange for quicker access to funds, an approval process that is less demanding, and the possibility of greater flexibility in the repayment schedule.

What Are Hard Money Loans Used For?

Once you obtain your hard money loan, there are a variety of things you can use it for, including but not limited to:

  • Flipping A House
  • Purchasing Investment Property
  • Purchasing Commercial Property

 

As you can imagine, there is more than one use for hard money loans, and what you choose to use it for can completely depend on your financial circumstances and plans. 

What is BRRRR?

BRRRR is concept used by professional house flippers meaning: buy, renovate, rent, refinance, repeat. You can use a hard money loan to assist you finish the BRRRR process if you don’t want to wait the four to six weeks that it takes to close on a mortgage refinance.

 

Pros and Cons of a Hard Money Loan

Pros

The approval process for a hard money loan is typically much faster than the application process for a mortgage or other regular loan through a bank, which is one of the advantages of these types of loans. Because the lender is more concerned about the applicant’s collateral than their current financial situation, the private investors who sponsor the hard money loan are able to make decisions more swiftly.

The time that lenders spend confirming income and going over financial paperwork, for example, is reduced when they receive electronic applications for loans. The procedure will go even more smoothly if the borrower already has a working relationship with the lending institution.

Investors in hard loans aren’t as worried with getting paid back because, in the event that the borrower defaults on the loan, there is a possibility that they may be able to resell the property at a higher price, giving them more profit.

Cons

Hard money loans typically have lower LTV (loan-to-value) ratios than traditional loans because the property itself is utilized as the only insurance against default. The LTV ratio for hard money loans is typically between 50 and 75 percent, whereas the LTV level for ordinary mortgages is 80 percent (though it can go higher if the borrower is an experienced flipper).

In addition to this, the interest rates are typically quite high. It’s possible that the interest rates on hard money loans are much higher than those on subprime loans.

Because of the stringent regulatory oversight and compliance requirements, certain hard loan lenders may decide not to provide financing for owner-occupied properties. This is another disadvantage associated with these loans.

If you require finance in a non-traditional way, hard money loans can be a beneficial alternative. These loans, however, come with high interest rates and a large degree of risk if your venture isn’t as lucrative as you hoped. Hard money loans are best left to the professionals in general. However, this does not preclude them from being a viable alternative for some borrowers. Even the most flexible-term hard money loans have some of the same advantages and disadvantages as normal, non-mortgage consumer loans and personal loans.

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