Unless you intend to pay cash for your upcoming real estate purchase, you will need to obtain financing. The primary source of real estate financing that most people commonly think about comes from banks. The loans may be sourced through a mortgage broker or directly through a major financial institution. In many cases, these real estate loans are sold to another entity after closing. Your past experience with this type of residential loan may include providing the lender with a seemingly endless amount of documents and waiting at least two to three months to close. You may have had to provide so much documentation for your loan request in an effort to prove to the lender that your loan request meets its specific underwriting guidelines. In some cases, bank loans are turned down because one small factor did not fall into place. Banks and financial institutions are not the only resource that you can use for to fund real estate projects. Hard money loans can also be considered, and they may be well-suited for specific situations and needs.
How Hard Money Loans Are Different
There are several key ways that hard money loans are different than bank loans. One difference is in the terms. Hard money loans usually have an interest rate that may be higher than a typical credit card interest rate. They may also have a very short term that is less than 18 months, a balloon payment and high fees compared to bank loans. Why would someone use this type of financing? Bank loans have rigid underwriting guidelines and an overall lengthy loan process. Hard money loans do not have specific underwriting guidelines. The lender has extreme flexibility to consider all loan scenarios that make sense and to structure loan terms that make sense for the project. In addition, hard money loans do not have applicant requirements, such as the need for you to have a minimum credit score. Another important difference is in the closing time. Hard money loans may close within two to three weeks in many cases.
A Closer Look at Hard Money Lenders
You may be wondering what makes hard money loans so different than bank loans. The answer lies in where the money is coming from. Banks usually use their own funds temporarily to fund projects, but the loans are often sold quickly after closing. The entities that buy the bank loans only want to purchase low-risk loans that comply with specific guidelines. This means that bank loans must comply with those guidelines strictly. Hard money loans, on the other hand, are privately funded. A private lending company or sometimes a private investor may fund the loan. These private sources commonly retain the loan themselves rather than sell the loan after closing. Because of these factors, they do not have to conform to underwriting guidelines, and they can consider any real estate loan request that is reasonable.
How to Use Hard Money
Because of the short term and fast closing time for hard money loans, these loans are often used for specific situations. For example, you may have a balloon payment due soon or a 1031 exchange with a pending deadline. Hard money can be used in these situations because of the fast turnaround time. The short term associated with hard money loans makes them most well-suited for scenarios that involve selling the property soon for a large profit, such as a renovation project. Some applicants also use hard money loans to reposition a project so that they can obtain a permanent loan within a short period of time.
Bank loans are a great financing option for long-term needs and for projects that comply with their guidelines and requirements. For many other types of lending scenarios, hard money is a wonderful alternative. Now that you understand what hard money loans are, you can keep this financing option in mind as you examine future real estate investment opportunities.