Hard money loans are nonconventional forms of real estate financing. The application process, qualifying requirements, interest rates, and repayment terms differ markedly from conventional and even subprime loans. Hard money stands in a lending league of its own.
In certain circumstances, hard money loans help borrowers who otherwise would be unable to obtain financing. They provide a lifeline to borrowers who are at risk of losing the equity in their properties to foreclosure or bankruptcy. They allow investors to purchase properties when conventional approval takes too long. They also offer homeowners in need of money for home repairs a method of fixing damages without being forced to abandon the home or sell at a loss.
Are the interest rates on hard money fixed or floating?
Hard money interest rates are fixed for the loan term. When the loan term expires, a balloon payment comes due. A balloon payment is the entire balance of the loan. Because hard money loans are for a much shorter period than traditional mortgages, balloon payments are very large. Most hard money loan borrowers either refinance or sell their property before the balloon payment comes due.
Though hard money loan interest rates remain fixed until the balloon payment comes due, many hard money loans come with a penalty interest rate if the borrower falls behind. Most conventional mortgages have no penalty interest rates, though they have late fees. In regards to penalties, hard money loans work much like credit cards. With credit cards, late payments result in a large interest rate increase, often to the maximum rate allowed by law. Hard money loans also frequently contain provisions allowing default interest rates to rise to the legal maximum, often upwards of 25 or 30 percent.
The non-penalty interest rates for hard money loans vary widely, between 7 and 20 percent. Some of the variance is due to the lender. Both the lender’s risk tolerance and the competitive demand for hard money loans affects the rates, so, if considering a hard money loan, always shop around with several lenders.
The property value primarily drives hard money loan interest rates. In hard money loans, the value and condition of the property are the most important factors. Credit score and the income and stability of the borrower are either secondary factors or are not considered at all. Hard money lenders are able to apply a property-based standard because they lend only a low percentage of the property’s value and are the first lienholder.
Most hard money lenders lend a maximum of 80 percent loan to value (LTV). As first lienholder, the hard money lender has the right to foreclose and repossess the property. Because the LTV on hard money always remains low, the lender is assured of a handsome profit should the borrower default. For this reason, hard money lenders are willing to loan to individuals with bad or no credit, assuming that the property provides sufficient equity.
Borrowers who own properties in good locations receive much lower interest rates than borrowers who own properties in average or poor locations. Remote locations also lead to premiums for hard money interest rates. Properties in poor or remote locations may be difficult for the lender to sell in case of default, so the lender demands increased risk protection in the form of higher interest rates. Conversely, properties in hot real estate markets promise the hard money lender big profits should the borrower default, and the lender knows that borrowers are less likely to default when property values are surging. If the property is easy to sell, the borrower will likely sell it before defaulting, decreasing lender risk.
Hard money loans often come with points. Each point is 1 percent of the loan value. For example, if borrowing 100,000 with three points, the borrower is charged $3,000 in points. Points are charged in addition to the regular interest rate.
As with interest rates, the amount of points charged depends on the property. Properties in great locations generally qualify for lower point loans than properties in poor or remote locations. Poor property condition results in more points, while great property condition may result in a point discount.
Some hard money lenders look at borrower’s credit history and income. Though hard money lenders accept borrowers with poor credit who have fallen behind on their mortgage or other bills, some add to the points or interest charged to customers with bad credit. Some also offer discounts to those with good credit.
While interest rates and points may seem high compared to conventional loans, it is important to understand that hard money loans are designed as short-term bridge financing. No one takes out a hard money loan and pays the interest for 30 years. Most hard money loan terms are for a year or two.
Hard money loans provide the bridge that allows borrowers to secure a property, make repairs, or save their equity in case of foreclosure. Once borrowers get past the situations that require hard money, they either sell the property or refinance into a conventional loan.