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While many borrowers are able to successfully get a conventional loan through a bank, there are some situations that make these loans difficult or impossible to acquire.
For these scenarios, a hard money loan may be the best option.
Hard money loans are often known as last-resort loans, but they can be an instrumental part of your real estate toolbox.
Using our hard money loan guide, learn more about these types of loans and how they might be the perfect solution to your real estate goals.
What is a Hard Money Loan?
Hard money loans are funded by individuals or companies rather than banks. These loans are asset-based, and use the property value as collateral. Banks, on the other hand, provide loans based on the borrower’s financial status.
Since hard money loans are asset-based, the terms are much more flexible than conventional loans and focus on each unique deal.
They are usually short-term loans meant to provide quick access to cash, though some lenders may offer longer loan terms. Hard money loans often are closed in as quickly as five to 10 days.
Hard money loans often come with a higher cost to borrowers and a lower loan-to-value ratio, but the flexibility and speed can be so valuable to borrowers that the terms are worth it.
The borrower and the lender decide on terms together. Repeat borrowers may find it beneficial to form a working relationship with their hard money lender so they can get the best terms with each deal.
How Hard Money Differs from Bank Loans
Conventional loans from banks require strict documentation, including W-2s and income statements. They require a solid credit score and low debt — and if you’re a real estate investor, your requirements are even more strict. After a certain amount of properties, investors are no longer eligible for loans backed by the government.
Hard money lenders have requirements, too, but they’re more flexible and deal-based rather than ticking boxes.
These lenders usually will want to see bank statements, tax documents, and your credit score, but they still may be willing to work with you if your credit score isn’t great or you lack certain documentation.
For hard money lenders, it’s more about a borrower’s general financial health and the value of their exit strategy: How is the borrower planning to pay back the loan, and what is the timeline? Does the deal make sense?
Hard Money Loan Considerations
Hard money loans don’t work for everyone, but they have the potential to unlock a whole other world of deals that borrowers may not think are possible.
A trusted lender can guide you on whether a hard money loan is right for you.
Benefits of Hard Money
The greatest benefits of hard money loans include the speed and flexibility.
A quick, straightforward approval process based on the property rather than the borrower means less time verifying their financial status and more time evaluating the actual deal at hand.
This can be ideal for investors hoping to flip and sell a property quickly.
Hard money lenders use their industry experience and knowledge to quickly decide what makes sense to them and what they are willing to fund.
Another benefit to hard money is the relationship between borrower and lender.
If you’re a real estate investor or love to fix and flip houses, you often will need another loan to seal those deals quickly. A hard money lender who knows and trusts you will be able to help you with your transactions.
Drawbacks to Hard Money
Since the loan terms are much shorter than conventional loans, the interest rates can be quite high. This is also due to the increased risk of the borrower, since the financial requirements are less strict overall.
Hard money loans also often have lower LTV ratios than conventional loans. Loan-to-value (LTV) ratios look at the amount of the loan compared to the property value.
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When to Use a Hard Money Loan
Today, hard money loans are acquired by real estate investors and developers. Banks tend to be strict for these borrowers. The drawbacks are worth it to these professionals, because the deals may otherwise be impossible.
The following types of borrowers may benefit from hard money lending.
Real Estate Investors
Hard money loans are used for both residential and commercial properties. Real estate investors across the board can find value in these flexible loans. This includes:
- Rental properties
- Hotels
- Vacation homes
- Office buildings or warehouses
- Malls or retail stores
- Single-family homes
- Fix-and-flip
Government-backed Fannie Mae limits the number of investment properties to 10, but some banks aren’t willing to do that many since there’s so much work involved. Seasoned investors might need other options to fund their properties.
Self-Employed Borrowers
Self-employed borrowers can have difficulty getting a conventional loan because they lack the necessary paperwork.
Especially if you’re newly self-employed, you won’t have the required tax and income documentation for the bank to see.
If you have enough money to purchase a property but can’t prove it, a hard money loan can help you get the funds you need to purchase your home and then switch to a conventional loan.
Borrowers with a Low Credit Score or Rough Financial Past
Borrowers who have faced bankruptcy, foreclosure, or other legal troubles have to wait to be eligible again for a conventional loan.
These types of borrowers are seen as too risky to banks. Hard money lenders may be willing to give them a chance if their deal and current situation make sense.
Also, borrowers with poor credit but a lot of equity in their property can cash out using a hard money loan.
The Bottom Line
Hard money lenders evaluate borrowers on a case-by-case basis, so if you think this type of loan is right for you, contact a lender to discuss your situation.
Choose a lender based on a recommendation or after thorough research. This lender may be a part of your real estate team for many years to come, so choose wisely.
If your situation is more straightforward and you’re able to provide the required documentation, a conventional loan probably is right for you.
For investors, properties needing rehab, or for more complicated financial scenarios, a hard money loan may be your best option.
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