Hard money lenders generally charge points and interest. 5 points and 15 percent interest are average, though lower fees and interest are attainable in certain markets. At the outset, it may seem like hard money loans are expensive, but when applied to the right real estate deal, they actually provide the borrower tremendous savings. They can also provide investors with the opportunity to purchase properties with less money out of pocket and much faster than with conventional loans.
How hard money points work
Points on hard money loans work the same way as points on conventional loans. A point is one percent of the loan amount. If you wish to borrow $100,000 and the lender charges five points, you pay $5,000 in points. Often, the points are baked into the loan rather than paid out of pocket.
For example, if you borrowed $100,000 in hard money with five points, then the points increase the loan value to $105,000. When you sell or refinance the property, you must pay back $105,000, plus interest. Borrowers sometimes pay points up front to save on interest, but most hard money borrowers (and borrowers in general) lack sufficient cash to pay points up front.
How hard money lenders determine the number of points to charge differs from conventional mortgage lenders. Conventional mortgage lenders base much of their lending decisions on the creditworthiness of the buyer. Even in subprime mortgage loans, the borrower’s credit score and income stability play a significant role in the lending decision and interest rate.
Hard money lenders often give no consideration to the borrower’s creditworthiness. Rather, they base their decision on the value of the property. Generally, hard money lenders want to provide loans that are less than 80 percent loan to value (LTV). The LTV is the percentage of the loan compared to the value of the property. Lenders in the hard money sphere keep the LTV below 80 percent to protect themselves against default.
Because hard money lenders lend without credit and income checks, they face a higher risk of default. By requiring that LTVs always remain below 80 percent, the lender assures itself that should the borrower default, the lender can recover his losses by repossessing and selling the property.
Since the lender’s risk ties to the property value instead of the borrower’s creditworthiness, hard money lenders base points primarily on the characteristics of the property. For example, hard money lenders may charge two to six points for properties in good locations, three to eight points for properties in average areas, and five to twelve points for properties in poor locations or remote areas. Lenders also factor loan size into their determination of points.
The lender may also give a discount for properties in good condition but add points for properties in poor shape. A property with significant problems poses a higher risk for the lender. Some lenders may also give a point discount or increase based on the strength of the borrower’s credit. Loans that are required very quickly may also incur additional points.
How interest rates are determined
Hard money lenders use the same criteria of property location and condition that they use in determining points. Properties in good locations may merit rates of nine to 12 percent interest rates. Lenders may give loans on average location properties 10 to 13 percent interest rates. Borrowers on properties in poor and remote locations can expect interest rates between 11 and 14 percent. Some lenders also give interest rate discounts and increases based on property condition and credit.
Some hard money lenders charge prepayment penalties, so if shopping for a hard money loan, be certain to inquire about prepayment. Since hard money loans are for short terms, usually one or two years, many borrowers are willing to accept prepayment penalties because they intend to pay off the loan through a sale or refinance after the prepayment penalty period expires.
Penalty interest rates
Conventional mortgages generally charge a fee for late payments, but they do no charge a penalty interest rate. Hard money loans are different. Like credit cards, hard money loans charge higher interest when customers pay late. For instance, a hard money customer may have a loan at 12 percent interest and because of a late payment, the lender increases the interest rate to 20 percent.
Though hard money loans incur fees, they provide tremendous savings. Borrowers with equity in their homes who face foreclosure can use a hard money loan to stop the foreclosure process and preserve their equity. The borrower is then free to sell or refinance the property. The equity that the borrower has preserved far outweighs any points and interest the borrower paid on the hard money loan.