What Is a Hard Money Loan?
A hard money loan is a type of loan that is secured by real property. Hard money loans are considered loans of "last resort" or short-term bridge loans. These loans are primarily used in real estate transactions, with the lender generally being individuals or companies and not banks.
Key Takeaways
- Hard money loans are primarily used for real estate transactions.
- They are generally money from an individual or company, and not a bank.
- A hard money loan is a way to raise money quickly but at a higher cost.
- Because hard money loans rely on collateral rather than the financial position of the applicant, the funding time frame is shorter.
- Terms of hard money loans can often be negotiated between the lender and the borrower.
- These loans typically use property as collateral.
How a Hard Money Loan Works
Hard money loans have terms based mainly on the value of the property being used as collateral, not on the creditworthiness of the borrower. Since traditional lenders, such as banks, do not make hard money loans, hard money lenders are often private individuals or companies that see value in this type of potentially risky venture.
Interest Rates on Hard Money Loans
Hard money loans generally have a higher interest rate than traditional mortgages. As of July 2022, the average interest rate offered on a hard money loan was between 10% and 18%. This makes hard money loans much more expensive than a regular mortgage, which during the same month offered an interest rate of between 4% and 5%.
For flippers and short-term investors, this might not matter. They may plan to pay the loan back quickly, and this will reduce the effect of a high interest rate and make the loan cheaper. For most other people, however, it makes sense to look for a loan with a lower interest rate. The primary advantage of a hard money loan is speed; if you can wait a few months for your loan to come through, it might be better to look at refinancing your home or taking out a personal loan.
Examples of Hard Money Loan
Hard money loans are typically used by real estate investors, developers, and flippers. Hard money loans can be arranged much more quickly than a loan through a traditional bank. In some cases, hard money lenders can issue funds in as little as 10 business days, while traditional banks have a wait time of 30-50 days for funding. Most hard money lenders can lend up to 65% to 75% of the property’s current value, and loan terms are generally short - 6 to 18 months.
Hard money loans may be sought by property flippers who plan to renovate and resell the real estate that is used as collateral for the financing—often within one year, if not sooner. The higher cost of a hard money loan is offset by the fact that the borrower intends to pay off the loan relatively quickly.
Hard money loans may be used in turnaround situations, short-term financing, and by borrowers with poor credit but substantial equity in their property. Since it can be issued quickly, a hard money loan can be used as a way to stave off foreclosure.
Hard money lending can be viewed as an investment. There are many who have used this as a business model and actively practice it.
Special Considerations for Hard Money Loans
The cost of a hard money loan to the borrower is typically higher than financing available through banks or government lending programs, reflecting the higher risk that the lender is taking by offering the financing. However, the increased expense is a tradeoff for faster access to capital, a less stringent approval process, and potential flexibility in the repayment schedule.
Pros and Cons of a Hard Money Loan
As with any financial product, there are advantages and disadvantages to hard money loans. These loans are quick and easy to arrange and have high loan-to-value (LTV) ratios, but also high interest rates.
Pros
One advantage to a hard money loan is the approval process, which tends to be much quicker than applying for a mortgage or other traditional loan through a bank. The private investors who back the hard money loan can make decisions faster because the lender is focused on collateral rather than an applicant's financial position.
Lenders spend less time combing through a loan application verifying income and reviewing financial documents, for example. If the borrower has an existing relationship with the lender, the process will be even smoother.
Hard loan investors aren't as concerned with receiving repayment because there may be an even greater value and opportunity for them to resell the property themselves if the borrower defaults.
Cons
Since the property itself is used as the only protection against default, hard money loans usually have lower LTV ratios than traditional loans: around 50% to 75%, vs. 80% for regular mortgages (though it can go higher if the borrower is an experienced flipper).
Also, the interest rates tend to be high. For hard money loans, the rates can be even higher than those of subprime loans.
Another disadvantage is that hard loan lenders might elect to not provide financing for an owner-occupied residence because of regulatory oversight and compliance rules.
What Are Typical Terms for Hard Money Loan?
Hard money loans are a form of short-term financing, with the loan term lasting between 3 and 36 months. Most hard money lenders can lend up to 65% to 75% of the property’s current value, at an interest rate of 10% to 18%.
Is a Hard Money Loan a Good Investment?
It depends what you use the money for. Hard money loans are a good fit for wealthy investors who need to get funding for an investment property quickly, without any of the red tape that goes along with bank financing. They can be useful to pay for a one-time expense or project, but only if you are reasonably sure you'll have the money to pay back the loan.
What Are The Risks of a Hard Money Loan?
Hard money lenders typically charge a higher interest rate because they're assuming more risk than a traditional lender would. They may require a higher down payment than a traditional loan would, and you'll have a shorter period to pay back the loan.
The Bottom Line
Hard money loans are typically used by real estate investors, developers, and flippers. They can be arranged much more quickly than a loan through a traditional bank, and loan terms are generally short - 6 to 18 months. Hard money loans may be sought by investors who plan to renovate and resell the real estate that is used as collateral for the financing. The higher cost of a hard money loan is offset by the fact that the borrower intends to pay off the loan relatively quickly.
