If you’re interested in a loan you can get quickly for financing a home purchase or keeping your home from getting foreclosed on, a hard money loan is one common option. It’s most commonly used by people who flip houses, and it’s important to understand the ins and outs of a hard money loan before you apply for one.
The Basics on a Hard Money Loan
A hard money loan is a secured loan, and its collateral is a piece of property (almost always real estate). You can borrow a hard money loan by using a piece of property that you own as collateral, but most borrowers get hard money loans to buy properties that they plan to improve, and then sell for a profit.
You may be wondering what the difference is between a hard money loan and a mortgage. The most significant difference is that with a hard money loan, the key factor in your approval on the loan is the value of the property attached as collateral, along with how much money you plan to put down. Unlike more traditional lending options, your credit score isn’t nearly as important in obtaining hard money loan.
Hard money loans aren’t usually available through traditional lenders, such as banks and credit unions. Instead, individual investors and investor groups provide this type of loan.
Interest rates on hard money loans are higher than on mortgages, and terms tend to be much shorter. It’s normal for hard money loans to have balloon payments, with borrowers covering just interest with all their payments until the final one, and then needing to pay off the remaining balance.
This loan structure makes hard money loans ideal for house flippers, as they can get the money, make small loan payments while they upgrade the home, and then sell the home before the end of the loan’s term. The goal is for them to make enough money to pay back the loan, along with a sizable profit.
Advantages to Hard Money Loans
Now that you have an accurate idea of what a hard money loan is, it’s time to look at the reasons why you would choose a hard money loan over a mortgage.
There are two big advantages hard money loans have over other lending options:
As anyone who has ever tried to get a mortgage would know, it’s not an easy process. You need all kinds of documentation, the mortgage lender will be taking an extensive look at your financial profile, and all things considered, the process could take months. That may be fine if you have plenty of time to choose and buy your house, but it doesn’t work when you need to close a deal quickly.
The hard money loan application process is significantly faster. Depending on the lender, you may apply and have your loan fully funded within a couple weeks or even less than one week. And when you’ve worked with a hard money lender before, you can typically get loans approved faster. This makes a huge difference if you’re flipping homes and it’s a race between you and other interested parties.
Hard money lenders are more willing to take on risk than mortgage lenders. A mortgage lender may not want to go near certain homes that appear rundown or full of issues. If you can show a hard money lender the improvements you’re going to make to the home, you still stand a good chance of approval. And, of course, your credit score isn’t nearly as important for a hard money loan as it would be for a mortgage.
Final Thoughts on Hard Money Loans
The last thing to know about hard money loans is that you’ll likely need to pay a solid chunk of the home’s asking price yourself, because lenders usually only loan about 75 percent of the home’s current value, at most. If you’re lucky, you’ll find a lender that bases the amount they loan you on how much the home could be worth after you make your repairs and upgrades. While this reduces how much money you need to put down, expect a higher interest rate for that convenience.
Hard money loans certainly aren’t right for everyone, but their speed and flexibility can be extremely useful in certain circumstances. Evaluate what you need a loan for and how soon you’ll be able to pay back what you borrow to decide if a hard money loan is the best choice. Ultimately, it will come down to what loan you can get quickly enough while minimizing how much you need to pay in fees.
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