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Complete Guide to Hard Money Mortgages

flip-homeWhat is hard money?

"Hard money" or a "private mortgage" refers to mortgages made out of the mainstream. Most traditional banks and mortgage origination companies take weeks to close a home loan. And they have to comply with laws that don't allow them to lend to people with a high default risk or hard-to-verify income.

So hard money comes from private lenders. That means individuals or groups of investors who put their money up for short-term borrowing. Private lenders are largely exempt from laws that mortgage lenders must obey. And they can approve and fund loans very fast.

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Who needs hard money?

Many believe that these loans are just for non-prime borrowers. And while homebuyers with poor credit or hard-to-prove income do take these loans, they are not the main clients of hard money lenders.

In fact, most customers of hard money lenders are property investors. They might have lines of credit they can tap to pull the trigger on a fast buy. Or they have their private lender on speed dial for quick decisions and fast funding whenever they spot a property they want. Alternatively, they might pay cash for the home - perhaps at auction - and then use a private lender to get their cash back out. They can then use that money to rehab the property or purchase another one.

Compete with cash buyers

What if you see the chance to buy an ugly but decent property, make some cosmetic improvements and flip it fast for a 30% gain? That's great, but those opportunities don't come up that often, and you'll probably have competition.

What if you're competing with cash buyers? How do experienced investors buy fast without cleaning out their savings? By borrowing hard money.

Related: How to Buy and Finance Investment Property

Finance "weird" property

Not everyone wants to finance traditional residential property in neighborhoods. Hard money lenders finance many kinds of property, including:

  • Mixed use property
  • Residential property
  • Condotels
  • Rentals
  • Commercial property
  • Farms
  • Multi-unit homes
  • Apartment buildings

Some lenders specialize in one type of loan. You may have to search more if looking for something very specific, like financing to finish an abandoned construction project.

How fast can a hard money loan fund?

The normal turnaround time for a private mortgage is a couple of weeks. However, once you have established a relationship with a private lender, you might get your cash in three-to-five days, or even sooner.

The reason for this high speed is that private lenders can ignore a couple of laws that apply to residential mortgage lenders:

  • Private lenders funding investment property don't need to comply with the Ability to Repay (ATR) rule. This means they don't have to ensure that your income is sufficient to repay the mortgage.
  • Loans with terms less than 12 months are exempt from most consumer protection reforms implemented by the Dodd Frank Act in 2014.
  • Lines of credit for investors are also exempt.
  • There is no law setting minimum credit standards. Hard money lenders protect themselves by structuring their loans so that they could recoup their funds in a foreclosure sale.

Without all of the typical government-mandated consumer protections, you have to exercise more caution. But less verification does save time.

Related: Can You Make a Living Flipping Homes?

Why hard money?

Hard money is not for everyone (or even most people). Here are the most common reasons for hard money financing:

  • Fix and flips
  • Land loans
  • Construction loans
  • Buyers with credit issues
  • Investors who need to act fast

Not everyone can comply with traditional mortgage lender credit underwriting guidelines or prove their income in a standard way.

How much can you borrow with hard money?

Expect to make much larger down payments with a private mortgage. That is how hard money lenders protect themselves in risky transactions. They make sure that if they have to foreclose, they won't take a loss.

Many hard money lenders will lend 65% to 75% of the current value of the property. Some will lend based on the repaired value (ARV) for fix and flip or rehab transactions. The ARV is the estimated value of the property after the borrower completes specified improvements.

ARV loans are riskier because lenders put in a higher percentage of the property value and borrowers contribute less. So these loans do carry higher interest rates.

Some hard money providers lend a high percentage of the ARV and even finance the rehab costs. This may sound great for you, the borrower. But you can expect to pay 15 to 18% interest and 5 to 6 points (upfront) when a lender funds a loan with little to no down payment from you. It may be worthwhile to pay these high rates if you can still profit from the project.

Related: How to Buy a Foreclosure Home in a Healthy Market

How much does a hard money loan cost?

The cost of hard money financing depends on the amount of competition for your business. When there are more individuals and groups offering these loans, the price does tend to be lower. However, you don't see hard money lenders advertising on television or in the paper. You need to search for these loans, usually online or through real estate agents who do a lot of investment transactions. And you must get offers and compare them before committing.

Hard money lenders require higher interest rates and fees because they take on higher-risk loans, and because the loan terms are shorter. A traditional lender might experience a default rate of 1% and expect to earn interest on the loan for many years. While a private lender might collect interest for just a few months and have 20% of borrowers default.

As of this writing, a typical hard money loan carries an interest rate of 10% to 15%, depending on the borrower's credit rating and the size of the down payment. Points and fees can run from 2% to 5% of the amount borrowed, depending on the length of the loan term.

Alternatives to hard money

If you own your own home, have decent credit and a fair amount of home equity, you might be able to finance your flips economically.

  • Take a second mortgage against your primary residence and bank the cash until you need it for a fast property purchase
  • Obtain a home equity line of credit (HELOC) and write a check when an investment opportunity presents itself
  • A cash-out refinance may be the best when you have a lot of home equity and need a large amount of cash
  • You could even, if you're at least 62 years old, finance flips by taking out a reverse mortgage against your current home.

Without home equity, you may qualify to borrow up to $100,000 with a personal loan. The cost depends a great deal on your credit rating, and the availability depends on your income. Personal loans are unsecured and come with maximum terms of ten years. So the payment would be considerably higher than that of a mortgage even if the rate was comparable.

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