Real estate investing can be a lucrative avenue for building wealth, and it’s an effective way to diversify your portfolio. While real estate investment trusts (REITs) and real estate crowdfundingallow youto invest passively, some investors may prefer to own property directly.
If you’re not comfortable parting with a substantial amount of cash upfront to purchase real estate, a hard money loan may be the answer. While this type of loan has advantages over traditional financing, it does have potential downsides. A certain capital buffer is still required.
How Hard Money Loans Work
Hard money loans, sometimes referred to as bridge loans, are short-term lending instruments that real estate investors can use to finance an investment project. This type of loan is often a tool for house flippers or real estate developers whose goal is to renovate or develop a property, then sell it for a profit. Hard money loans are issued by private lenders rather than mainstream financial institutions such as banks.
Unlike traditional bank loans, the ability to obtain hard money financing isn’t determined by the borrower's creditworthiness. Instead, hard money lenders use the value of the property itself in determining whether to make the loan. Specifically, lendersfocus on the “after repair value,” orARV,which is an estimate of what the property will be worth once the renovation or development phase is complete.
The Cons
Hard money loans aren’t a perfect financing solution. There are two primary drawbacks to consider:
- Cost–Hard money loans are convenient, but investors paya price for borrowing this way. The rate can be up to 10 percentage points higher than for a conventional loan. Origination fees, loan-servicing fees, andclosing costsare also likely to cost investors more.
- Shorter repayment period–The purpose of a hard money loan is to allow an investor to get a property ready to go on the market as quickly as possible. As a result, these loans featuremuch shorter repayment terms than traditionalmortgage loans.When choosing a hard money lender, it’s important to have a clear idea of how soon the property will become profitable to ensure that you’ll be able to repay the loan in a timely manner.
The Pros
There are several good reasons to consider getting a hard money loan instead of a conventional mortgage from a bank. Here are the main benefits this lending option offers to investors:
- Convenience – Applying for a mortgage is time-consuming, particularly thanks to new regulations on mortgage lending implemented as part of the Dodd-Frank Act. It can take months to close on a loan, which puts investors at risk of losing out on a particular investment property. With a hard money loan, it’s possible to get funding in a matter of weeks. That’s important if you’re funding a large-scale development project and can’t afford deviations from the timeline to completion.
- Flexible terms – Because hard money loans are offered by private lenders, it’s possible for investors to have more room for negotiation of the loan terms. You may be able to tailor the repayment schedule to your needs or get certain fees, such as the origination fee, reduced or eliminated during the underwriting process.
- Collateral – With a hard money loan, the property itself usually serves as collateral for the loan. But again, lenders may allow investors a bit of leeway here. Some lenders, for instance, may allow you to secure the loan using personal assets, such as a retirement account or a residential property you own.
The BottomLine
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. When evaluating hard money lenders, pay close attention to the fees, interest rates, and loan terms. If you end up paying too much for a hard money loan or cut the repayment period too short,that can influence how profitable your real estate venture is in the long run.
FAQs
Hard money loans are secured, short-term loans often used to finance a home purchase. Real estate investors commonly rely on hard money loans to manage multiple flip projects. Hard money loans deliver cash quickly but at a higher interest rate compared to other types of financing.
What is a hard money loan in real estate? ›
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 lenders generally being individuals or companies and not banks.
Why would someone use a hard money lender? ›
A business owner may use a hard money loan to fund the purchase of commercial real estate. Hard money loans can be useful for entrepreneurs who don't qualify for conventional financing to purchase unique property. The same may be true for borrowers who find traditional commercial loan limits too low for their needs.
Is hard money lending a good investment? ›
Hard money loans have always been popular among investors for the purposes of renovating a property for a quick resale, but this type of financing also has significant value in speeding up a property acquisition while primary financing is still being hashed out with the lender.
How do I know if my hard money lender is legit? ›
Remember that if your lender is giving you a below 5% rate, more chances are that it could be a scam. Hard money lenders do not require any collateral. Remember that genuine hard money lenders often require collaterals, and if your lender is not keen about any sort of collateral, then that is a major red flag.
What is an example of hard money? ›
Another way to describe hard money is actual physical currency. In such a case, hard money would represent coins made out of precious resources, such as platinum, silver, and gold.
How do payments on hard money loans work? ›
Unlike a traditional home mortgage, hard money lenders typically only charge interest on a monthly basis, which means you don't actually pay any money toward the principal loan amount at each monthly payment cycle. However, you will have to pay back the full principal amount at the end of the loan's life cycle.
Do hard money loans hurt credit? ›
While not all hard money loans are reported, those that are can either positively or negatively affect your credit score, depending on your payment history. The key lies in choosing a lender who aligns with your financial goals and understands the nuances of credit reporting.
Can you refinance out of a hard money loan? ›
Fast Turnaround Times For Hard Money Cash-Out Refis
California Hard Money Direct can fully complete a cash-out refinance on a non-owner-occupied property in about 7-9 days. Owner-occupied refinance loans take a bit longer because of the mandatory guidelines all private lenders must follow.
Can you negotiate with hard money lenders? ›
Negotiating favorable terms with hard money lenders requires preparation, clear communication, and a solid understanding of your investment. By following these tips, you can maximize your borrowing potential and establish agreements that support your investment objectives.
Rates for hard money loans can vary, but the average interest rate is generally between 10% and 18%, which is significantly higher than a conventional loan. On top of that, other costs are often associated with these types of loans, including points and origination fees ranging from 2% to 6%.
What are typical terms for a hard money loan? ›
What are the typical loan terms for hard money loans?
- Size: Varies.
- Term: 12- 36 months.
- LTV/Leverage: Up to 90% LTV/Up to 80% ARV (after repair value)
- Interest Rate: Rates vary, but generally between 7.00 - 12.00%
- Closing Costs: 2.00 - 5.00%
- Credit Requirement: 550+ (can vary significantly based on lender)
If you default on the hard money loan at any point, the lender takes the property and sells it, using the funds to pay off the outstanding loan. The lender would only need to sell the home for 40% – 50% of its original sales price to make its money back.
What is proof of funds from hard money lender? ›
Obtaining a Proof of Funds Letter is commonly done prior to submitting your offer. This allows the Hard Money Lender to underwrite you as a borrower prior to receiving a loan request. By getting pre-approved, the underwriting and funding process will go much quicker and will be one less step in your closing process.
What is a point of hard money lender? ›
Points are a fee charged by the lender that is expressed as a percentage of the loan amount. They are used to compensate the lender for the risk they are taking on by issuing the loan. One point is equal to 1% of the loan amount, and lenders may charge more or less depending on the level of risk they are taking on.
Is a hard money lender the same as cash? ›
Ultimately, Hard Money is Not Cash
At the end of the day, hard money can be an effective cash substitute in real estate transactions, but it is not the same thing as cash. It is a loan that must be repaid with interest, and it is typically used as a short-term financing solution for 6-12 months.
What is hard money vs soft money in real estate? ›
A soft money loan requires more underwriting than a hard money loan, allowing it to have lower rates and greater security. It is based on both the borrower's credit score and the property's LTV and is usually a term loan rather than a bridge loan.
Do hard money loans show up on credit? ›
Though hard money loans typically do not show up on your credit report, they still appear on other documentation, such as background and asset searches.
