What Is A Hard Money Loan?

Image: Getty Images; illustration: Bankrate

What is a hard money loan?

Hard money loans, also called bridge loans, are short-term loans commonly used by real estate investors, such as house flippers or developers who renovate properties to sell. They can also be a good tool for borrowers with assets but poorer credit or those who are facing foreclosure.

Hard money loans are usually funded by private lenders or investor groups rather than banks, using equity or real property as collateral.

How does a hard money loan work?

Hard money loans are secured by the property they’re tied to instead of the borrower’s credit and financial profile. The loan is typically based on the property’s value and comes with a very short repayment term, usually less than a year.

Some hard money loans are structured as interest-only loans, followed by a large balloon payment. This makes them riskier than other kinds of financing.

Hard money loans vs. traditional mortgages

Hard money loans operate differently than a traditional mortgage in several ways:

• Timeline: Applying for and closing on a hard money loan is often much faster than with a traditional mortgage — and the repayment terms are much shorter than the usual 15- or 30-year timelines. You’ll usually repay a hard money loan within six or 12 months, though some terms may be longer.
• Rates: Interest rates for hard money loans tend to be much higher than those for a traditional mortgage.
• Down payment: While a conforming conventional loan can be had for just 3 percent down, if you qualify, a hard money lender will often require at least 20 percent down, if not 30 percent or more.
• Risk: Unlike a traditional mortgage, which is backed by the borrower’s creditworthiness, hard money loans are secured by the physical property and its assessed value in the form of equity. If you default on a hard money loan, you’ll generally lose the asset you put down as collateral, rather than being able to work out a repayment plan.

Who is a hard money loan best for?

The types of borrowers who tend to get hard money loans include:

• Property flippers: People who buy properties to renovate and resell for a profit often choose hard money financing, says Julie Aragon of the Aragon Lending Team in the Los Angeles area. “Property flippers turn to hard money loans because they can lock in funding almost overnight. That speed gives them a serious edge over buyers stuck waiting for a traditional lender.”
• Those who don’t qualify for traditional loans: There are many reasons why a borrower might not qualify for a 30-year, fixed-rate mortgage from a bank, such as a recent divorce that affected their credit score. An inability to document income can also be an issue for some business owners and freelance workers: “Self-employed people who write everything off might be able to afford a mortgage, but their taxes don’t reflect that,” Aragon says.
• Homeowners facing foreclosure: Although this isn’t a common scenario, some homeowners are at risk of foreclosure even though they have a lot of equity in their homes. Hard money lenders would consider lending in this situation if they can be assured that, should the loan go into default, they can sell the house, pay off the first mortgage and still earn a profit from the sale.

How to get a hard money loan

1. Find a lender

While you can probably name many traditional mortgage lenders, you likely haven’t heard of any hard money lenders. The best way to find one is through a referral from a real estate professional, including real estate agents, settlement agents, title officers or real estate attorneys.

2. Meet requirements

To get a hard money loan, you must meet certain requirements. These vary by lender, but some of the most common criteria include:

3. Gather documentation

Like preparing for any loan application, it’s important to gather your documentation, including your identification, income information, tax statements, bank statements and other financial statements.

4. Compare lenders and apply

If you can, it’s smart to compare offers from multiple lenders. Look at the interest rates they charge and any associated fees. Then submit an application with your chosen lender, answering all questions and providing any required documents.

Pros and cons of hard money loans

Before you decide to work with a hard money lender, consider the pros and cons of this financing option:

Pros

• Speedy funds: Compared with the glacial pace of traditional mortgage underwriting, hard money loans can be processed in just days. For real estate investors, speed can make all the difference when it comes to closing a deal — for example, when bidding on a competitive property at auction.
• Flexible loan terms: Hard money lenders are not subject to the same regulations as conventional mortgage lenders, so they tend to be more flexible when negotiating terms.
• Don’t require a strong credit history: While traditional mortgage underwriting focuses on borrower income and credit history, hard money lenders extend loans based on collateral, such as a house or building. The estimated market value of the property — after planned renovations are completed — matters more than your financial history.

Cons

• Higher down payment requirements: You’ll need to put down much more money to qualify for a hard money loan than you would for a conventional mortgage. While qualified borrowers can get a conventional mortgage for as little as 3 percent down — and other loan types require no down payment at all — hard money lenders typically mandate closer to 20 or 30 percent down, if not more.
• Higher fees: Hard money loans are more costly in other ways, too. The interest rates can be several percentage points higher than rates for conventional mortgages, and the upfront fees are also much more expensive. In addition, you could be charged a prepayment penalty if you pay your loan sooner than the term dictates.
• Looser lending regulations: Hard money lenders are similar to payday lenders in that they’re subject to little oversight or regulation.

Alternatives to hard money loans

There are a few alternatives to a hard money loan, including:

• Private money loan: These arrangements are potentially informal and may have very flexible terms, as they are less regulated than hard money loans.
• Fannie Mae HomeStyle loan: These funds can be used for renovations and repairs, but you must meet eligibility requirements, like having a credit score of at least 620.
• Cash-out refinance: If you have enough equity in your home, you could apply for a cash-out refinance and use the funds remaining after you’ve paid off your mortgage instead of a hard money loan. This will likely increase your monthly mortgage payment, though.
• Home equity line of credit (HELOC) or home equity loan: You can use a HELOC or home equity loan if you have enough equity built up in your home and meet eligibility requirements. Both act as a second lien on your home.

FAQ

• What are hard money loan rates?

  Hard money loan interest rates might be in the double-digits — far higher than the rates for 30-year, fixed-rate mortgages. The rates and fees are typically determined by how much financing you require and the value of the deal to the lender.

• Are hard money loans risky?

  Yes, hard money loans can be risky. This is primarily because they come with higher interest rates and shorter repayment terms than typical mortgages, and they have limited regulations in comparison. This means that you, as the borrower, would have very little protection if you needed help repaying the loan. Likewise, if you use a hard money loan to flip a home and can’t sell it, you’d be on the hook for a potentially large sum and could even lose the property.