Hard money loans are asset-based loans that are common among real estate developers. The loans are easier to obtain than traditional mortgage loans that require credit checks. Hard money loans utilize the property as collateral which helps clients avoid lengthy credit and income checks. These loans have a lower loan-to-value (LTV) ratio than traditional loans because they utilize the property as the protection against default by the borrower. The LTV ratios may vary between 50% to 70% which means that borrowers need assets to qualify for the loan.
Breaking Down Hard Money Loans
Traditional loans require proof that a borrower can pay them back. The proof is the credit score and income status, which means that a majority of borrowers may be cut off due to poor credit scores or unreliable income sources. Even with the evidence in place, further investigations are conducted before loan approval, which makes the process extremely slow for a developer looking to bid on the prime property.
Hard money lenders use a different approach and instead lend based on the collateral securing the loan. This means that less attention is given to the borrower’s ability to pay back and if a borrower defaults, the lenders can take the collateral and sell it. Hence, the value of the collateral is more crucial than the financial position of the borrower.
Usually, hard money loans have higher interest rates than traditional loans. Banks do not deal in these types of loans, and therefore, most lenders operate as private institutions. A hard money loan can operate as a short term loan for a borrower who has substantial equity in his property and is looking to avoid foreclosure, even with a poor credit score.
Hard money loans are popular among property flippers looking to renovate a property and can contract a loan over a short period- over 6 to 24 months. This gives the developer enough time to bid for property they intend to renovate while still avoiding hefty interest rate payments. A developer can sell off the property within a year and sell it off to pay off the hard money loan. Despite the higher interest rates as compared to traditional loans, the benefits usually offset the disadvantages.
For real estate developers, hard money loans provide the ideal opportunity to purchase property without the need for upfront capital which results in great returns for their investments. While the cost of a hard money loan may be higher than that of traditional loans obtained from banks, developers are willing to make the risk. The higher cost is a tradeoff for faster capital access and less stringent rules in the underwriting process.
However, hard money lenders may opt not to fund owner-occupied residences due to the regulatory oversight required to complete financing. It is crucial to note that at times, the lenders may not be too keen in getting their money back, because, there may be greater value in reselling the property if the borrower defaults.
How are Hard Money Loans Different?
There are several aspects that differentiate a hard money loan from a traditional loan or a direct loan.
Speed: First, hard money lenders are barely concerned with a borrower’s financial position in terms of their credit score or income. This allows the lenders to move quickly through the lending process. Less time is spent combing through bank and income statements. Borrowers can obtain loans within days if they are well prepared and if the property they intend to develop has no red flags.
Flexibility: Hard money loans also provide borrowers with adjustable repayment schedules. Traditional lenders must adhere to a strict repayment schedule, which may not always work in favor of the borrower. However, a hard money lender is allowed to make minor adjustments to the repayment schedule because hard money lenders are not bound by strict guidelines. This flexibility works to the advantage of real estate developers who may require more time to pay off the loan.
Approval: Additionally, the approval of hard money loans is primarily based on the value of a property rather than a borrower’s credit history and experience. However, this does not mean that anyone qualifies for the loan. Credit history and experience are still essential in borrowing from hard money lenders.