The vast majority of people who are looking to purchase real estate do not have the cash on hand to meet the full asking price. As a result, the single largest source of household debt today is due to mortgages. However, while traditional mortgages usually meet the requirements of the average home buyer, who often seeks to live in their own home for years or decades, they are not always the best option for real estate investors or people who want to improve then immediately sell properties.
Hard money loans can be the perfect tool for investors
A hard money loan, on the other hand, has a number of features that make it particularly appealing to real estate investors and home flippers. Hard money loans are short-term sources of financing that are usually issued by private investors or groups of investors. As a result of not being issued by large banks, borrowers going with hard money loans can often seek much more flexible terms than they would otherwise be able to get from a traditional mortgage. In exchange, borrowers will end up paying considerably higher interest rates. Surprisingly, however, these loans often have significantly lower up-front costs. This feature can make them especially useful for sophisticated investors looking to leverage their capital.
Hard money loans are fast
One of the most serious problems that real estate investors will face in competitive markets is being able to assure the seller that they can close a deal quickly. Traditional mortgages do not make good tools for real estate investors in markets where average selling times are less than three months. The typical mortgage approval process is long, and anything out of the ordinary can cause the process to drag on for months.
Even for investors with impeccable credit, the delay in being approved for mortgage loans can mean that these are not viable options to use as a means to close deals. On the contrary, hard money loans can get investors cash in hand within a couple of days. Once investors establish relationships with hard money lenders, the entire approval process may only take a matter of hours. This can give investors a decisive edge in competitive real estate markets.
Hard money loans save huge on up-front costs
Even in areas where real estate investors may be able to use traditional mortgages effectively, they may still want to consider a hard money loan instead. One reason is because of the much reduced up-front costs. On a typical $100,000 home purchase, a buyer using a traditional mortgage will often be forced to cough up as mu1ch as $30,000 before the deal is closed. About $25,000 of this will be for the down payment and there will be an additional $5,000 in closing costs and origination fees.
On the other hand, using a hard money loan on the same purchase, an investor may only need to pay around $5,000 in order to get the deal rolling. While the interest rate will typically be considerably higher on the hard money loan, usually around the 15-percent mark, the up-front costs are dramatically lower. This is because hard money loans are always fully collateralized with real assets.
This means that the buyer using the hard money will have to sign off another piece of real estate, usually amounting to about twice the value of the loan. This ensures the lender that if the buyer defaults, then the lender will easily be able to sell the collateral and recoup the entire principal amount.
Even with the risk of putting up collateral, which can sometimes be partially covered by the asset being purchased, hard money loans can still be attractive because they allow the investor to leverage their cash to the maximum.
While hard money loans are often great tools for investors, they typically do not make good sources of long-term financing. If hard money is the only source of financing available, the borrower should be looking to refinance as soon as possible.