In the world of real-estate finance, the vast majority of projects where cash is not used to cover the entire purchase price involve mortgage financing. Mortgages are extremely popular forms of purchasing residential real estate because they allow buyers to acquire homes that they would almost certainly not be able to afford without access to long-term financing. For most prospective home buyers, mortgage financing is an appropriate and useful choice.
However, there are some situations where traditional mortgages don’t fit with the goals or limitations of a real estate buyer. In many situations where the home needs extensive repairs or is in some way has a seriously compromised current market value, traditional mortgage lenders may view the deal as being too risky for a traditional mortgage. In other cases, the buyer themselves may be viewed as too great a credit risk. If a buyer is involved in too many deals at once or has highly variable income, traditional home lenders may not be willing to assume what they perceive to be a high level of risk to underwrite a mortgage.
In these situations and many others, a home buyer may want to turn to what are known as hard money loans. A hard money loan is a real estate loan made by an individual investor or group of investors, usually on a local basis. Because hard money loans are originated by individuals rather than huge corporate banks, the terms of the deal can be almost infinitely flexible. This allows creative real estate investors to structure deals in ways that are most likely to meet their specific goals. In exchange for vastly increased flexibility, hard money loans often have higher rates of interest. But paying more interest is usually not a concern as these loans are almost always used as a kind of short-term bridge financing.
Hard money loans don’t involve extensive due diligence
One of the most attractive features of hard money loans is the incredibly fast underwriting period. Unlike applying for traditional mortgages, which involves banks combing over everything from pay stubs to personal spending habits, hard money loans almost never involve extended due diligence procedures. This is because they are backed by real estate. In most cases, the value of the real estate being purchased supplies a good deal of the collateral. Some hard money loans are also collateralized against other real estate owned by the borrower. Because hard money lenders typically give loan-to-value ratios of between 50 and 70 percent, they typically don’t care about the borrower’s credit score, income or other cash flows. They know that if something goes wrong, they will easily be able to recoup their principal amount with interest.
Hard money loans can give real estate investors the edge
The reduced workload and the high level of flexibility involved in underwriting these loans mean that hard money loans can often get the borrowers cash in hand within a few days. In some cases, real estate investors who have established relationships with hard money lenders may be able to finalize new loans and get the money wired on the same business day.
For investors operating in hot real estate markets, this can make hard money loans as good as cash. Often, sellers in markets where the average selling time for a home is measured in a few weeks are hesitant to get involved with buyers who may face long waiting periods in securing financing. Doing so would not only precludes better offers, it also would mean the seller may wait months only to have the deal fall through because the buyer wasn’t approved.
Hard money barrowers, on the other hand, can often guarantee a closing with a timeframe of days. This can make the difference between consistently nabbing the best deals and being left behind in a kinetic real estate market.
Hard money can also reduce out-of-pocket costs by tremendous amounts, allowing sophisticated investors to more adeptly leverage their capital.