Updated by Craig Berry
If you've ever bought a home and didn't qualify for traditional financing, you may be familiar with the terms "hard money loan" or "private money loan."
How do hard money loans work?
The Federal Housing Administration (FHA) has been enjoying some of their busiest fiscal years, but getting an FHA-backed loan may not be enough. Many sellers prefer taking an all-cash offer to dealing with the challenges that sometimes arise when buyers offer with conventional or FHA loans.
For reasons like these, hard money loans, usually offered by private investors in exchange for a security interest in the property, have come back into style. Hard money lenders tend to take a different approach.
Hard money generally comes from individuals or groups of investors who lend money based primarily on the property being used as collateral. If anything goes wrong and you can't repay, hard money lenders plan to get their money back by taking the collateral used for the loan and selling it. Generally, the value placed on the actual collateral is worth more than your financial position.
Hard money loans
Most homebuyers pursue a hard money loan because they either don't qualify for a standard mortgage or they need money quickly.
The good news for hard money loans is, unlike traditional home loans, which can take several weeks to process, hard money loans can be ready in as few as a couple of days.
Hard money loans usually do not require credit checks or financial disclosures. Hard money, however, can come with a "catch" or two:
- Most hard money loans carry higher interest rates than traditional loans
- Processing fees are costly, many times up to three points or more
- Down payment requirements for hard money loans are typically as high as 30 percent or more
- Some hard money loans carry penalties should you decide to pay the loan off early, also known as a pre-payment penalty
Hard money loan programs generally carry short terms, typically from one to five years in length. It wouldn't be advantageous to keep a hard money loan longer than that because hard money loan rates are generally higher than traditional home loans.
Hard money loans for real estate
The most common use of a hard money loan is to fund the acquisition and rehab of investment properties.
While FHA 203(K) loans are an option, hard money loan qualifications are more flexible and can be obtained rapidly. As such, hard money is frequently used by fix-and-flip investors to renovate and sell properties within three months to a year.
Even long-term investors may use hard money when in need of renovating or upgrading a property before refinancing into a permanent mortgage.
Real estate investors tend to enjoy the aspect of making an interest-only payment on hard money, knowing they may soon sell the property to repay the principal amount. This can be especially appealing to investors who are looking for cheaper payments up front, in order to get a bigger return on their investment down the road.
Is hard money lending right for you?
Hard money loans are ideal for short-term investors, including fix-and-flippers who purchase, renovate, and then sell a property within 12 months.
Hard money can also be great for long-term investors who find and purchase a home in less-than-perfect condition, renovate it, and then turn it into a rental property. These loans can also be used to season a property before refinancing it.
Interest rates and points charged by hard money lenders can vary from lender to lender and may also vary from region to region.
As an example, hard money lenders in California generally have lower rates than other parts of the country since California has many hard money lending firms. Basically, increased competition leads to a decrease in prices charged by competing hard money lenders.
Hard money lenders take on more risk with their loans, as compared to conventional home loans. Due to this higher risk, interest rates for a hard money loan typically range between 10-15% depending on the lender and the perceived risk of the loan.
Points can vary anywhere from 2-4% of the total amount loaned. Interest rates and points tend to vary rather significantly depending on the loan-to-value ratio.
Finding hard money lenders
In order to borrower money from these quasi-loan sharks, you must get connected with investors. In order to do this, find out who in your area lends money based on collateral. Local real estate professionals and mortgage lenders can be a great source for these connections.
Prior to diving in, reach out to a few lenders and real estate agents to discuss your needs. You can develop a relationship that allows you to fund projects quickly and easily when the time comes. Or, if you aren't comfortable with the high cost and high stakes of hard money lending, explore today's mortgage rates from conventional lenders.