What is a hard money loan?
A hard money loan is a type of loan secured by real estate. Hard money loans are considered “last resort” or short-term bridging loans. These loans are mainly used in real estate transactions, with the lender usually being individuals or businesses and not banks.
Key points to remember
- Hard money loans are mainly used for real estate transactions and are money from an individual or business and not from a bank.
- A hard money loan, usually taken out for a short term, is a way to raise funds quickly but at a higher cost and a lower LTV ratio.
- Because hard money loans are based on collateral rather than the financial condition of the applicant, the financing time is shorter.
- The terms of hard money loans can often be negotiated between the lender and the borrower. These loans generally use the property as collateral.
- The borrower’s default can always result in a profitable transaction for the lender through the collection of collateral.
How a hard money loan works
Hard money loans have terms based primarily on the value of the property used as collateral, not the creditworthiness of the borrower. Since traditional lenders, such as banks, do not do hard money loans, hard money lenders are often individuals or businesses who see value in this type of potentially risky business.
Hard money loans can be sought by real estate investors who plan to renovate and resell real estate used as collateral for financing, often within a year or even sooner. The higher cost of a hard money loan is offset by the fact that the borrower intends to repay the loan relatively quickly – most hard money loans are for one to three years. – and some of the other benefits they offer.
Lending hard money can be viewed as an investment. Many have used it as a business model and are actively practicing it.
Special considerations for hard money loans
The cost of a hard money loan to the borrower is generally higher than the financing available from banks or government loan programs, reflecting the higher risk the lender takes in offering the financing. However, the increased spending is a trade-off for faster access to capital, a less stringent approval process, and potential flexibility in the repayment schedule.
Hard money loans can be used in turnaround situations, short term financing, and by borrowers with low credit but substantial equity in their property. Since it can be issued quickly, a hard money loan can be used as a way to avoid foreclosure.
Advantages and disadvantages of a hard money loan
There are pros and cons to hard money loans related to the approval process, loan-to-value (LTV) ratios, and interest rates.
One of the advantages of a hard money loan is the approval process, which tends to be much faster than applying for a mortgage or other traditional loan from a bank. Private investors who support hard money lending can make decisions faster because the lender focuses on the collateral rather than the applicant’s financial position.
Lenders spend less time going through a loan application to verify income and review financial documents, for example. If the borrower has an existing relationship with the lender, the process will be even smoother.
Outright loan investors are not as concerned with repayment as there may be even greater value and opportunity for them to resell the property themselves if the borrower defaults.
Since the property itself is used as the only protection against default, hard money loans generally have lower LTV ratios than traditional loans: around 50% to 70%, compared to 80% for loans. ordinary mortgages (although it may increase if the borrower is an experienced palm).
Plus, interest rates tend to be high. For hard money loans, the rates can be even higher than those for subprime loans. In 2020, the average interest rate for a hard money loan is 11.25% with rates varying from 7.5% to 15% for the United States in 2020.
Another downside is that tough lenders may choose not to finance an owner-occupied residence due to regulatory oversight and compliance rules.