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What is Hard Money Loan?
When we talk of hard money loans, we are referring to short-term, interest-only loan that investors use to buy and rehabilitate distressed properties. These loans will normally command higher interest rates of up to 12% p.a. but they can be available in as short as 15 days. For this reason, it arms the investors the capacity to compete with all-cash buyers. These loans usually carry a term of 1-3 years.
It is a loan given by a private lender or a group of lenders to individual or businesses. They are “asset-based” loans which mean that the borrower has to pledge the property he is investing in as collateral to secure the loan.
Since private investors are the ones funding the hard money loans and not traditional banks, people also call them ‘private money loans’. Another unique thing about them is that since they are ‘asset-based’, lenders will often look at the value of the property and not primarily on the borrower’s credit score or financial history.
To determine the loan amount, they will use the loan-to-value ratio (LTV). To get that, divide the loan amount by the value of the property offered as collateral. Hard money loans may be faster and relatively easier to get than conventional loans but borrowers still have to go through the underwriting process and comply with certain terms and requirements.
Investors also call hard money loans as bridge loans and they often use them when they need a quick loan for their fix and flip projects. These loans are popular because:
- It’s easier and quicker to pre-qualify for them.
- Faster funding time.
- They are interest-only loans.
- They have shorter terms.
- There are less borrower qualification requirements.
Of course, there’s a downside to all this convenience and speed and that is the cost – hard money loans are expensive. There are no general terms and requirements for them because each lender will have his own but they will depend on the property investor’s experience and property type.
The usual turn-around time for a hard money loan is one to two days but in some cases, a lender can approve a loan on within the day.
Example of a Hard Money Loan
Let’s say John needs money for his monthly bills and his next paycheck isn’t until another week. However, traditional lenders won’t lend him money due to his poor credit history. Even if John doesn’t have an excellent cash flow, but he’s already built up $130,000 equity in his home.
So, John goes to an independent private investor who agrees to lend Darren up to $50,000 in hard money loan but Darren has to pledge his home as security for the loan.
Reasons For Using a Hard Money Loan
Sometimes, it’s better to get a hard money loan instead of a traditional financing. Here are some reasons why:
- You have a property investment opportunity on the table and can’t waste time going through the long and tiresome bank loan process.
- You don’t have a high enough credit score or your income history does not meet bank and other traditional lender standards. Even if you’re bringing in a hefty income but you’ve just started working, the bank may deny your request for a loan because of insufficient income history. Hard money lenders don’t mind these things very much as long as you can repay the loan and you have adequate equity on your property.
- You don’t have ready cash and can’t borrow from your family or friends.
- You’re trying to fix and flip properties and urgently in need of financing. Unlike traditional lenders who can be inflexible, hard money lenders will try to find the best fit package for your project and will give you more benefits when you do more business with them.
- Your capital is insufficient to cover the rehabilitation cost of the property you are eyeing to buy and sell.
Hard Money Loans Requirements
When you’re trying to get a loan from a bank, you first need to fill out a long application form. You need to disclose information about your finances, credit history, employment history, debt ratio, income, personal assets, liabilities, etc. They can also ask for a letter of explanation.
Also, before they even consider your application, they would have to evaluate the collateral property you’re offering if it meets their guidelines. After filing your application, it normally takes around 30 days or more for the bank to check your information, evaluate your application and decide if they will give you a loan.
They would also require you to make a down payment of somewhere between 10% to 20% of the purchase price of the property.
But with hard money loans, you may not need to fill out a long application form depending on the lender. Why? Because most hard money lenders have no need or use for that much information just to give out a loan.
Most national hard money lenders usually require the following:
- A credit score of 550+ (You can check your credit score online for free)
- The property locations & purchase price
- Bank statements dating back 2-3 months
- A description of prior projects with the details, number of homes that you’ve successfully flipped
- Intent and property documentation (include the scope of work and insurance)
If you would like to borrow a hard money loan, you should be ready to provide the lender with a valid purchase contract, a list of your past projects, contractor bids, and a scope of work if you’re planning to rehab the property. Another difference in hard money loan compared to conventional mortgages is that there is no strict limit to the number of hard money loans you can get. What’s more, hard money loans do not discriminate based on the condition of the property – they can finance a property in almost any condition.
Important: Hard money lenders comply with federal and state laws so they can not lend to people who can not repay the loan. By law, the hard money lender has to make sure that the borrower has the financial capacity to meet the monthly interest payments and the ensuing balloon payment.
How do You Find a Hard Money Lender?
You could tap your own network, ring other property investors to get referrals, or browse the internet to find a hard money lender.
There are many ways to find a good hard money lender if you are willing to do what it takes.
Probably the easiest way to search for a local money lender is to Google for one by typing your area or city and adding the words ‘hard money lenders’. You could get as much as 150,000 search results that will list individual companies as well as a compilation of lenders on different websites and blogs. This will already give you enough leads to call and find your ultimate hard money lender.
Your realtor or local real estate investment group can refer lenders in the area. You can also look through the state-by-state hard money lender directory that provides a list of lenders in all 50 states.
A good way to find a hard money lender is by going to local real estate investor club meetings. These clubs hold their meetings in most cities and are quite popular with hard money lenders who are looking to network with potential borrowers.
Pros and Cons of Hard Money Loans
Hard money loans can be a great alternative in some cases, but you should always consider and understand the different pros & cons before getting any decision:
Fast approval and fast funding. In a lot of cases, lenders approve loan applications within one day.
Fewer requirements. Hard money lenders only ask for a few requirements, not like the traditional banks or financing companies.
Very flexible. Most hard money lenders don’t use a standard underwriting process.
Low credit scores are acceptable. It’s common knowledge that banks will shut their doors to a borrower with a low credit score. Hard money lenders won’t always do that because they make their decisions based on the profitability of the subject property and not principally on the borrower’s credit score.
Higher interest. Hard money loans are expensive because they have a high interest rate. On the upside, borrowers tend to finish their rehabs faster and sell their properties quicker.
More sizeable down payments. Hard money loan lenders will often require a down payment of at least 25% to 30% or a 25% to 30% equity in a property that the borrower owns in case of refinancing. Bank loans will require only a down payment of 20% but some programs like FHA ask for a smaller down payment.
Risk of foreclosure. If the borrower fails to pay the monthly interest payments, or neglects to maintain or repair the property, or defaults on the loan itself, he could lose the property due to foreclosure.