A non-traditional way to obtain funds is through a hard money loan. This type of loan is provided by investors who offer lending based on property collateral. When a person is unable to obtain a loan through traditional means, the hard money approach may be the only option. The following explains how this type of loan works.
What is a Hard Money Loan?
The majority of loans are created based on repayment ability. This is dependent on a person’s income and credit score. If the individual has has a good track record of borrowing money and paying it back, that person will likely get the loan they need. Traditional lenders can be very slow to approve loans, even if the applicant has an excellent income and solid credit rating. An individual with a negative credit history or an unverifiable income may never get a loan approval.
A hard money lender offers a loan based on the collateral a person provides, such as a home or land. This loan is typically easier to get because it is not based on the ability to repay it. If the borrower cannot pay the money back, the lender simply takes the collateral and sells it to recover their funds. The collateral has a higher value than the borrower’s credit rating or income. Since the interest rate for a hard money loan is much higher than a traditional loan, it is practical for only a short period of time, averaging between one to five years.
Why Get a Hard Money Loan?
With a higher interest rate, a hard money loan may not seem like a good choice. For those who cannot qualify for a traditional loan, it does offer the following benefits:
• Fast money. A hard money loan closes more quickly because the lender is not concerned with a borrower’s financial status, only the collateral provided. Lenders also do not need to invest time in looking at bank statements or verifying a borrower’s income. Once the relationship has been established, the loan process can proceed smoothly, and the borrower will get their money right away.
• Flexibility. Since each hard money loan is evaluated individually, the approach offers more flexibility than the traditional loan process. Depending on the borrower’s circumstances, repayment schedules can be adjusted to better suit both parties. This is because there is a direct relationship between lender and borrower, rather than borrower and a company with strict rules.
• Approval. The main concern for hard money lenders is collateral. Most are not concerned with a borrower’s credit history, although some may ask general financial questions during the approval process. Lenders like a low loan-to-value ratio because this will allow them to quickly sell a property if the borrower defaults.
When Does it Make Sense to Use Hard Money?
Hard money is best suited as a short-term loan. This type of financing is often used by those who buy and “flip” houses. It makes sense because the borrower only occupies the property long enough to increase its value. If the person wants to stay there indefinitely, it is better to refinance.
Drawbacks of Using Hard Money
While hard money loans are generally easy to get, they are not a perfect solution. They are costly, and the plan has to work smoothly for all parties to profit. In addition, lenders may value collateral property at a lower value than the borrower prefers. Borrowers should also consider other types of financing, which may help them come out ahead in the long term. A person may qualify for an FHA loan even without a perfect credit history. Interest rates for hard money loans can run into double digits, and the borrower may be forced to pay an origination fee to close the loan.
How to Find Hard Money Lenders
Those who need to borrow money and want to obtain a hard money loan can reach out to local real estate investor groups and agents for the names of lenders who operate based on collateral. Talking with a few different lenders and building strong relationships is the road to getting funds quickly when they are needed.