Many of us have heard the term “hard money loan”, but do you fully understand what that means, and when you should consider using one?

The many rules and regulations concerning mortgages sometimes make it difficult to obtain a mortgage. As everyone that has ever applied for a mortgage knows, you must fit into the box created by those rules and regulations.

A hard money loan is based on the value of your collateral rather than on your ability to repay the loan. There are several kinds of hard money loans, used at different times to serve various purposes. It is a good idea to know and understand these loans so you can use them to your advantage. If you work in the real estate industry you may need to explain and advise your clients concerning these loans.

Bridge loans are used when there is an understanding that it will be for a short period of time. It might be used when a person is waiting for their current home to close but they need to put a down payment on a new home. It could be for a property that is bought with the understanding that it will be refinanced or sold within a short period.

Most of us understand a “fix and flip” loan. It allows a person to purchase a property that needs to be rehabbed and will then be sold.

A construction loan will allow a developer to build homes and sell them as they are completed.

An owner occupied loan allows individuals that cannot qualify for a regular mortgage to purchase a home that they will occupy.

Hard money lenders are private individuals or firms that consider loans on an individual basis.

Most lenders will only do hard money loans for investment purposes. Most hard money loans are for a term of 12 months or less. This type of loan does not require monthly payments applied to principal and interest; some are structured for monthly payments of interest only and some don’t require monthly payments at all but have a date at which the entire amount is due.

There are several advantages to this type of loan that appeals to real estate investors. One is the ability to obtain financing quickly, sometimes in a week. The fact that they can get the loan for a short term and the ease of the application process are also appealing.

The investor is normally required to put up some of their own money for the purchase. This is based on the loan-to-value or the after-repair-value.

The loan is normally paid off with what is known as a “balloon” payment at the end of the term. This payment will include all interest, the principal and any other costs that have been incurred during the term of this loan.

By now, you probably suspect that there are also some pitfalls to this type of loan. The interest rate can be significantly higher than regular loans.

There is very little oversight to this type of loan. This could make you vulnerable to unscrupulous lenders. The government is not looking over your shoulder ready to step in and protect you.

This type of lender is likely to charge all types of fees associated with the loan, and they can be substantial.

The short term of the loan can be a problem if you run into difficulty selling the asset. The loan could come due and the money would not be available to pay it.

An investor could also find a lot of red-tape when it comes to refinancing the asset.

As you can see, each circumstance is very different and the pros and cons must be considered carefully.