What is a hard money loan? | Mortgages and advice

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Real estate investors and real estate investors don’t have to rely on traditional mortgages to fund their projects – instead, they can take out a hard cash loan. A hard money loan is secured by real estate and is usually offered by non-traditional institutions such as investors, investment groups, commercial lenders or individuals. The duration of hard money loans is short, so these loans are commonly used to buy, renovate and sell real estate.

Although hard money loans are secured by the collateral of the property, they can be risky. Hard money loans usually include financing to buy the house and renovate it, but there’s no guarantee that you’ll be able to sell the house for more than the original loan amount.

Even so, these loans can be a good option in certain circumstances. Learn more about how a hard money loan works and when it might be right for you.

How to qualify for a hard money loan?

The qualifying process for a hard money loan is not as rigorous or time-consuming as a typical home loan application, but lenders still have certain requirements.

  • Credit history check. Although lenders usually put a lot of effort into your credit history, they aren’t primarily looking for a particular score. “When we apply for credit, what we typically look for more is payment history and any potential red flags on a credit report rather than the credit score itself,” says Erica LaCentra , Director of Marketing at RCN Capital. , a national hard money lender. Lenders may still have certain credit score requirements. For example, RCN Capital requires a FICO score of 660 for short-term hard money loans.
  • Solid business plan. When applying for a hard money loan, you may also need to provide the lender with your plans for using the loan. “We’re going to look at an individual’s level of experience, so if they’ve ever had a turnaround, and we’ll also look at their rehab budget and the project as a whole, to make sure the borrower knows what they’re into. they get on board,” says LaCentra. Some lenders may also require your proposed project to have certain profit margins. For example, RCN Capital typically requires a 10% return on investment.
  • Business incorporated under certain circumstances. To get a hard money loan, some commercial lenders may also require you to have a registered business entity. Small investors may be willing to lend to individuals.
  • Secondary residence or property. Many lenders require the property to be non-owner occupied, as they want investments that can return quick profits, either from the sale of the property or rental income.

What conditions are available?

While hard money loans are most often used for short-term construction projects, borrowers can also use them as residential mortgages on properties they plan to renovate and rent out. Hard money loans for flip projects typically have terms ranging from 12 months to two years, while hard money mortgage terms can be up to 30 years.

Financing for hard money loans is usually up to 80% to 90% of the purchase price or appraised value of the property and up to 100% of renovation costs. Hard-money loans can have different terms than traditional financing, which is why Cynthia Meyer, certified financial planner, real estate investor and founder of Real Life Planning, says borrowers should read their loan documents carefully before signing. .

What are the benefits of a hard money loan?

  • You get funding for your flip project. Hard money loans can finance projects that may be too risky for traditional financial institutions, such as banks or credit unions. Through hard money loans, borrowers can obtain financing to buy, renovate and sell properties, covering part of the purchase and renovation costs.
  • Loan approval is not based on personal credit. This means that existing debts or a lower credit score will not prevent you from getting a loan.
  • The loan does not appear on your credit report. Hard money loans aren’t reported to the credit bureaus, so they have little impact on your credit. There is only one credit check during the loan application process.
  • Interest only payments are available. Some hard money loans offer interest-only payments for the term of the loan and a lump sum payment at the end. This allows borrowers to make lower payments during the renovation and sale process and to repay the majority of the loan after the property is sold.

What are the disadvantages of a hard money loan?

  • Requires experience. Hard money loans can be riskier financing, especially for borrowers new to house flipping. Lots of things can go wrong, says Meyer. “They have this financing and they can’t meet the terms of the long-term financing – either they can’t meet the payments, or they can’t sell the property in a short enough time, or they just gobbled up all their profit on renovation costs,” she says.
  • No guaranteed sale price. The principle of house flipping is that by buying a distressed property, quickly remodeling it, and then selling it while the market is still hot, you can make a profit. However, real estate markets change all the time and there’s always a chance you won’t be able to sell for a high enough price to pay off the loan. In this case, you still owe the balance. “If you can’t sell the property within the time allowed, or if you can’t sell it and make money on it – so you might owe more on the loan than you were able to get from the property – then you would be responsible for the difference,” says Meyer.
  • Higher interest rates. Since hard money loans don’t come from traditional lenders, like banks or credit unions, they tend to have higher interest rates. Rates can be between one and eight percentage points higher, depending on how the lender — which is usually a private entity or person — assessed the risk of the transaction, Meyer says.

What are the alternatives to hard money loans?

There are several alternatives to hard money loans, including:

  • Get a second mortgage. To finance renovations on a property you already own, you might choose to get a second mortgage. For this type of financing, you will need to meet the lender’s credit requirements and pay two mortgages at the same time.
  • Get a personal loan. Personal loans do not require collateral and can be used for a variety of purposes, including home renovations. Personal loans, however, have lower limits than hard money loans. You will not be able to buy and renovate a property with a personal loan.
  • Use a credit card. For smaller financing amounts, you may be able to open a credit card with an introductory 0% APR for purchases. Credit cards can have higher interest rates than a hard money loan, but if you’re having trouble qualifying for traditional financing, hard money loans can have just as high rates.
  • Take a smaller project. If the reason you can’t qualify for financing is due to a lack of cash reserves or bad credit, Meyer recommends reconsidering the flip project. “Maybe you should wait a bit on this project and take on something a little smaller because it might be too risky,” she says.

Should you get a hard money loan?

With their short terms and higher interest rates, hard money loans are best suited to experienced pinball machines with manageable projects that can turn a profit. For those experienced borrowers, LaCentra says the default rate is low and most can pay off their hard money loans sooner.

For borrowers who have less experience in buying, renovating and selling projects or who have poorer credit histories, a hard money loan should be considered with caution. “Don’t take on a huge project for your first project,” says Meyer. “Do something where you can understand how the process works, how the funding model is going to work, and then learn from it first.” I hope you also have a cash cushion from your first project, she adds.

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