What is a Hard Money Loan and When is it Used?

Real estate investors are always looking for capital to make their next investment property purchase. In many cases, they often only have a few days to get the cash they need to make the purchase. These investors could go to a bank if they have excellent credit and finances, but it can take several weeks before they get their hands on the money they need. Understanding how hard money loans work is important for real estate investors to know so that they can make informed decisions when purchasing their next investment property.

What is a hard money loan?

A hard money loan is a type of mortgage that is primarily used by real estate investors. These types of loans are sometimes referred to as a “loan of last resort” because in some cases, homeowners who are facing foreclosure can also obtain a hard money loan. Most hard money loans have a 12-month term, but they can have terms ranging from 6 to 36 months depending on the project. A balloon payment is due at the end of the term, which means the borrower will need to sell their property or refinance the loan with a bank. Other common hard money loan terms include:

  • A fixed interest rate of 12 to 18 percent
  • 4 to 8 points on the loan
  • The loan is always in the first position
  • Loan-to-value is 50 to 70 percent
  • Loan is always secured by real estate

Who provides hard money loans?

Hard money loans are provided by a wealthy investor or a group of investors who use their own capital to fund the loans. Banks, credit unions, mortgage companies, and other financial institutions do not offer hard money loans. The hard money lending industry is less regulated than the banking industry, so it is important for a real estate investor to do their homework when looking for this type of lender. There are several things a borrower should investigate when looking for a reputable hard money lender:

  • A valid Real Estate Broker License
  • Any complaints filed against the license
  • Quality client/borrower references
  • Information from the Better Business Bureau

Real estate investors can find local hard money lenders online, at real estate networking events, from other real estate investors, from traditional mortgage brokers, and from industry publications.

Investors should also realize that hard money lenders generally specialize in lending on certain property types. For instance, one lender may only provide loans for single-family residences while another lender may only provide loans on commercial properties. Before the investor becomes a client of a hard money lender, they should know the types of properties they can get a loan on from the lender. Also, these lenders typically do not lend on owner-occupied residences largely because of the legal restrictions that are placed on these types of loans.

What are the advantages of a hard money loan?

A hard money loan may or may not be the right way to go about investing in real estate for every investor, but hard money loans do have some advantages. These include:

  • A simple application process with little examination of income, tax, or bank information
  • Fast decisions regarding approvals or disapprovals
  • The lender focuses on the profitability of the real estate rather than the borrower’s financial condition
  • Credit profile of the borrower is rarely a concern
  • Self-employment is not an issue

What are the disadvantages of a hard money loan?

Some of the disadvantages of these types of loans include:

  • Higher interest rates and origination fees
  • Hard money lenders are not as tightly regulated as traditional banks and other financial institutions
  • Some lenders may not have a good reputation
  • Some lenders may require a non-refundable deposit even when they know they do not have the capital to fund a loan

Experienced real estate investors know how to use hard money loans to their advantage. They know who are the good lenders, they know how the system works, and they know how to get the best rates and terms. New real estate investors may be shocked at the rates and terms they receive when they are approved for their first hard money loan. New real estate investors should work with a mentor when starting out if possible. Mentors can show these new investors how to find the best properties that have the most profit potential. These mentors can also help new investors to navigate through the loan process.