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 a “last resort” or short-term bridge loans. These loans are used in real estate transactions in which the lender generally being individual or company and not a bank.
KEY Points
- Hard money loans are primarily used for real estate transactions and are money from an individual or company and not a bank.
- A hard money loan is usually taken out for a short time and is a way to raise money quickly but at a higher cost and lower Loan-To-Value Ratio (LTV).
- Because hard money loans rely on collateral rather than the financial position of the borrower, the funding time frame is a lot shorter.
- Terms of hard money loans are negotiated between the lender and the borrower. These loans use the property as collateral.
- Default by the borrower can result in a profitable transaction for the lender thru repossessing of the collateral.
How A Hard Money Loan Works
Hard money loans have terms based on the value of the property being used as the collateral and not on the creditworthiness of the borrower. Traditional lenders, like banks, do not offer hard money loans. Hard money lenders are private individuals or companies that see value in this type of risky business.
Hard money loans are ofter used by property flippers who plan to renovate and resell the real estate that is used as collateral for the financing, often within one year or sooner. The higher cost of a hard money loan is used because the borrower intends to pay off the loan quicker. Most hard money loans are for 1 – 3 years.
Special Considerations For Hard Money Loans
The cost of a hard money loan to the borrower is higher than financing available thru banks or government lending programs, reflecting the higher risk that the lender is taking by offering the financing. The increased expense is a tradeoff for faster access to capital and a easier approval process and the flexibility of the repayment schedule.
Hard money loans could 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 hold off a foreclosure.
Pros And Cons Of A Hard Money Loan
There are pros and cons for hard money loans related to the approval process, loan-to-value (LTV) ratios, and 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 thru a bank. A private investor who backs the hard money loan can make decisions faster because the lender is focused on collateral rather than an borrower’s financial position.
For example, Lenders spend less time looking thru a loan application verifying income and reviewing financial documents. If the borrower has an existing relationship with a lender, the process will be even better.
Hard loan investors aren’t as concerned with receiving repayment because there may be an even better value and greater opportunity for them to resell the property themselves if the borrower goes in default.
Cons
Since the property itself is used as the only protection against default, hard money loans usually have lower LTV ratios than traditional loans. They are around 50% to 70%, vs. 80% for regular mortgage loans (it can be higher if the borrower is an experienced property flipper).
The interest rates tend to be high. For hard money loans, the rates can be even higher than those of subprime loans. In 2020, the average interest rate for a hard money loan was 11.25% with rates varying from 7.5% to 15%.
A drawback is that hard loan lenders might not provide financing for an owner-occupied residence because of regulatory oversight and compliance rules.