Hard money real estate loans can be a blessing for people who are looking to purchase a home but find themselves in unusual financial circumstances.
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Generally not a borrower’s first choice, hard money loans fill a gap between those who want to invest in a profitable real estate venture and those who don’t check all the boxes banks like to fill.
But what are these hard money loans? And what, more precisely, are hard money real estate loans? In which circumstances should you use them?
To make things clearer, here is the complete guide to hard money real estate loans.
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What Is A Hard Money Loan?
There are several ways a hard money loan is different from a standard loan.
- They come from individuals or private companies rather than traditional financial institutions like banks.
- They are non-conforming, meaning they are less standardized. Eligibility, features, and pricing can vary greatly per lender.
- They have a higher interest rate, sometimes several times the prime rate. This is to offset the higher risk the lender takes for this type of agreement.
- Most hard money loans are typically for short-term arrangements. They are akin to bridge loans.
- Collateral is the crucial difference. The lender generally bases a repayment schedule on the assets of the borrower instead of their cash flow.
- Hard money loans are popular for investors who want to deal in the real estate market.
All of that being said, since hard money loans don’t follow the same guidelines that banks do, the terms are up to the private lenders. This makes them more flexible and easier to obtain for many different groups of borrowers, including owner-occupied properties.
How Does It Work?
The most common reason a borrower may turn to a hard money lender is if their conventional loan or mortgage application was denied.
Another reason might be if the borrower needs to avoid the lengthy loan approval process via banks or other standard lenders.
Just like traditional loans, a hard money loan is secured. But the difference is that the security often comes through the value of the asset being purchased, usually a real estate property. The ‘hard’ part of the term “hard money” is the physical asset used to back the loan value.
The process is, on average, much quicker with a less rigid approval process — ideal for a quick turnaround if time is a factor for your project.
The term of the investment is usually much shorter than a conventional mortgage. Though some hard money lenders offer longer term loans for those looking to purchase a mortgage or plan to own the property for a while.
More detailed guides are available for hard money loans in general, but what about hard money real estate loans?
So, What Is A Hard Money Real Estate Loan?
If you are a real estate investor or flipper and need financing for your next deal, a hard money real estate loan might be an excellent option to explore.
For these types of loans, the asset that the borrower wants to purchase is itself used to secure the agreement. The lender focuses on the “after repair value” (ARV) of the property. The ARV estimates what the property might be worth once the renovations or developments have been completed.
If the property is intended to be owner-occupied, then the value won’t likely change that much when the term is complete. The lender, therefore, might ask for a higher interest rate to make the investment worth their efforts.
Why Use Hard Money Real Estate Loans?
For the general public, hard money real estate loans are almost always ‘last resort’ loans when they have exhausted conventional means.
For investors, the speed and ease they can complete often make them useful in the right circumstances.
If the borrower considering these loans has a poor credit rating or other financial hindrances, it’s not a deal-breaker. Hard money lenders are generally more interested in the property itself rather than the assets of the individual.
Hard money real estate loans are frequently cash deals. This type of loan might be a better choice in a seller’s property market if you have to close on a property quickly before other interested buyers can secure the desired location.
What Are The Requirements Of Hard Money Real Estate Loans?
Since the funds are supplied by private individuals or companies, hard money real estate loan requirements can significantly vary between lenders.
However, because the borrower and lender often deal directly with each other (or close to one another, at least), there is frequently more room to negotiate the loan terms.
First-time borrowers will likely find a more challenging time getting approved. The lender might need additional information to prove the borrower’s ability to quickly improve and sell the property.
Veteran borrowers or investors who have a proven track record make it easier to assess the project they’re proposing.
Most lenders who deal with hard money real estate loans might review the borrower’s investment history, the value of the property in question and require a 30-40% down payment to secure the loan.
But since these are private individuals or companies, there is much more flexibility to these guidelines. It is even possible to make an agreement without any down payment. So, shop around.
The Pros And Cons Of Hard Money Real Estate Loans
While there are many benefits to hard money real estate loans, there are also some details that might be a detriment to your plans.
- Interest — according to Freddie Mac, as of early autumn 2021, a conventional 30-year fixed-rate mortgage has an average rate of 3.01%. Compare that to hard money real estate loans with average rates of up to 8%, or even as high as 15%.
- Risk — a lender might be willing to dissolve the borrower’s organization and liquidate assets to repay the loan and outstanding interest. This will, of course, depend on the original agreement terms.
- Term — these loans are almost exclusively intended for short-term arrangements. If you are looking for a long-term mortgage solution, it’s likely better for you to seek out conventional avenues.
- Fast — with a standard or conventional mortgage, the application to closing process might easily take more than a month. With hard money real estate loans, there is the possibility of closing within a few days.
- Unconventional — if you are self-employed and therefore have a credit history that doesn’t fit into the banks’ requirements, these types of loans might be the way to go. Follow this link for more information about the benefits of owner-occupied hard money loans.
- Collateral — with hard money real estate loans, the property itself is used as collateral. It’s also possible to use personal assets like a retirement account or residential properties you own.
Hard Money Real Estate Loans: The Bottom Line
Hard money real estate loans can be a good match for investors who need funding for properties in a hurry. The lack of red tape that comes with banking institutions also makes these loans enticing.
Paying close attention to the fees, interest rates, closing costs, and loan terms is crucial. In the long run, these factors will determine how profitable your real estate venture might be.
The risks can be big. But if you play your cards right, so can the returns.
My Perfect Mortgage has a proven track record with hard money lenders as well as conventional ones. Matching the right lender to your investment needs is what we do best.
Start investing in your real estate future today with help from My Perfect Mortgage.