What Is a Hard Money Loan?
What is a hard money loan and how can it help you to buy a home? We’ve got everything you need to know. Click here to learn more!
It’s no secret that consumer borrowing continues to grow. In November of 2019 alone, auto loans, property loans, student loans, and credit cards accounted for over $4 trillion in debt.
Don’t assume this means borrowing money is a negative thing, though.
Most of those borrowing Americans have excellent credit and repay their loans in a timely fashion. In 2019, the average FICO score was at an all-new high of 703.
If you don’t have good credit or you simply need fast money for an investment, a hard money loan is a way to go. What is a hard money loan, you ask?
In this guide, we’ll break it down for you. We’ve got what you need to know to determine whether or not a hard money loan is a right choice for you!
What Is a Hard Money Loan?
Hard money lenders provide a way for people to borrow money without using traditional mortgage lenders. When an individual needs money quickly, or when a person doesn’t qualify for a conventional loan, a hard money loan is often their only option.
A hard money lender uses property or properties as collateral for the money they’re lending out. Rather than basing their approval decision on things like credit score and income, hard money loans use “hard” assets as collateral.
Credit history and income play a considerable role in determining traditional loan approval because those lenders want candidates with reputable re-payment histories and more than enough income to make monthly payments. A candidate with low income and bad credit is too risky and is less likely to pay back what they’ve borrowed.
Hard money loans are asset-based. Thus, if a borrower can’t pay, the hard money lenders will take possession of the asset used for collateral. They’re less concerned with a borrower’s ability to pay back what they’ve borrowed because they can always take the collateral as payment.
What Is Hard Money?
Hard money is money that gets lent to a borrower in exchange for their “hard” asset being used as collateral.
How Do Hard Money Loans Work?
A hard money loan is a short-term loan, typically lasting between 1 and 3 years, but it can also be any length between 6 months and 5 years.
Interest rates are typically higher on hard money loans, so it wouldn’t be in a borrower’s best interest to take out a long-term hard money loan.
Hard money loans allow real estate developers and investors to purchase more properties and conduct more deals with less upfront capital. In turn, it can result in an excellent return on their investment.
The asset used as collateral can be one the borrower owns already or one they plan to purchase with their hard money loan.
For example, say a developer borrows $1 million to buy and fix up a high-rise with the intention of turning it into apartments for rent. If things don’t go as planned and the developer can’t pay back what they borrowed, the hard money lender will take over the property as re-payment.
Are Hard Money Lenders Loan Sharks?
Loan sharks are hard money lenders. However, it’s important to note that all hard money lenders are NOT loan sharks.
An individual typically goes to a loan shark as a last resort. These individuals have no assets, questionable occupations, or bad credit.
If they don’t have any items of value to use as collateral or trade-in for the money they need, a loan shark is typically the next move. Loan sharks make money by using extremely high-interest rates, which can be against the law.
Many hard money lenders are reputable and professional, with interest rates that correspond with the law and a system in place to ensure successful lending outcomes.
Most Common Types of Hard Money Loans
There are a few different types of hard money loans, depending on what the borrower needs the money for.
Home equity loans are hard money loans. While borrowers can’t obtain home equity loans in all 50 states, they fund reasonably quickly where they are permitted.
They are subordinate to an existing first mortgage, and the loan amount gets determined based on the value of the property.
Bridge loans are another form of hard money loans. They’re used by sellers who want to buy a home before selling their existing home, but still, need the cash from the existing property.
Typically, bridge loans are more common in a seller’s market rather than a buyer’s market.
Mortgage refinancing is also considered a hard money loan. When borrowers refinance, they get a chance to pay off 1 or more existing loans secured to the property at hand. They get a new loan as a result, which usually has a bigger principal balance.
A homeowner might do this without taking any of the proceeds by rolling the costs of their new loan into the new principal balance or by paying the costs of the loan out of pocket.
What Are the Benefits of Using Hard Money?
Long gone is the stigma against hard money loans.
They are a reputable and smart way for many people to borrow money, especially those lenders with reviews that speak for themselves. Let’s take a look at the main benefits of using hard money.
Hard money loans can be much more flexible than traditional loans. Lenders approach every deal differently, rather than using a standard underwriting process.
Depending on you and the lender, you might be able to change the re-payment schedule or negotiate your interest rate.
They’re More Lenient With Credit and Income
Hard money lenders are less concerned with credit and income. It’s likely you’ll still fill out an application and answer questions, but the requirements aren’t as strict.
They’ll still want to take a look at your credit to see if you have any type of lien on the property in question. Sometimes they’ll charge an interest rate that is based on your credit score, but it’s much easier to negotiate with hard money lenders than traditional lenders.
Hard Money Loans Happen Quickly
Hard money lenders are less concerned with your financial position and more concerned with the collateral you’re offering. Hard money loan requirements are much more cut and dry.
Because a hard money lender knows they can seize your property as payment should you renege on your re-payment agreement, they spend less time reviewing your bank statements, verifying income, and delving into your credit history. Once you establish a relationship with a lender, the process can move fast, which gives a borrower the ability to close deals faster than others.
In hot markets where there is a lot of competition, hard money loans are almost always the only way to put yourself ahead of the competition.
Negatives Associated With Hard Money Lending
Hard money loans are excellent options for some and terrible options for others. Here are some of the disadvantages of using a hard money loan:
- Sometimes they require a large down payment
- Closing costs can be high
- Prepayment penalties may apply
- Interest rates can be high
- The appraisal process is more difficult
These cons won’t necessarily affect all borrowers. It all depends on who’s borrowing money and what negotiations they make with the lender.
Let’s take a look at who can benefit from hard money lending.
Who Should Use a Hard Money Loan?
House flipping investors use hard money loans a lot. The time it takes to get approved for a renovation loan can be too long, especially in a competitive market. With a hard money loan, an individual can be an all-cash buyer by getting funded quickly through a hard money loan.
If you’re trying to compete against cash offers for properties sold at property tax or foreclosure auctions, more often than not, you need to have cash within a certain time frame. If you don’t have enough on hand to bid, a hard money loan is the only option to skip the lengthy underwriting process of a traditional loan.
Having bad credit doesn’t mean you don’t have assets. Life happens. Sometimes unexpected medical bills get in the way, which can lead to bad credit. Sometimes a business fails, and the only option is bankruptcy. Hard money lenders don’t require a waiting period after bankruptcy or foreclosure, so if you have credit problems, a hard money loan is a way to go.
If you only need money for a short period of time, a hard money loan can easily satisfy those short-term needs. For example, if you need the cash to buy a new home and you know you’ll be able to sell your existing home soon after, a bridge loan is a perfect option to enable your big purchase before you sell your current abode.
What Is a Hard Money Loan?
What is a hard money loan? A hard money loan is an asset-based loan borrowed from hard money lenders rather than a traditional mortgage or other bank lenders.
If you’re in a pinch or you have bad credit, a hard money loan is an excellent option for all your borrowing needs. Plus, hard money lenders are much easier to negotiate with. If you’re wary of monthly payments or you aren’t happy with the interest rates, don’t hesitate to build a rapport with your potential lender so that you can come to an agreement that works for both parties.