When financing a real estate purchase, there are many ways to do so. While some people take out a mortgage from a local bank, others turn to private individuals and institutions to secure what is known as a hard money loan. While different from traditional mortgages in regards to interest rates, payback periods, and the application process, hard money loans offer various benefits mortgages simply cannot. However, they also come with pitfalls that can lead to trouble if they are not used in conjunction with sound financial planning.
How Do I Apply for a Hard Money Loan?
If you want to use a hard money loan to finance a real estate investment, applying for one involves knowing where to look. To get the best results and ensure you will be working with a reputable lender, turn to other investors. Since these loans provide tremendous flexibility in the types of investments for which they can be used, it is likely other investors in your area are using these loans as well, and can steer you in the direction of local hard money loan lenders.
Will I Need Collateral?
Just like any other loan, you will need collateral to secure a hard money loan. However, with these loans, the property you are wanting to purchase will act as your collateral. When trying to secure a hard money loan, the lender cares little about your past or present financial situation. In situations such as these, they are simply providing you a loan based on the property’s value. Thus, if it is valued at $100,000, the lender will probably offer you a loan in the neighborhood of $80,000, which will be based on the property’s loan-to-value ratio. If for any reason you buy the property and cannot sell it in time to pay off the loan, the lender will have the option of foreclosing on the property, or perhaps offering an extension at a much higher interest rate.
What is the Period of these Loans?
Regarding payback periods for these loans, this is one of the biggest differences between them and traditional mortgages. With a hard money loan, the payback period will be extremely short, probably no more than 12 months. Along with this short payback period, the lender will charge an interest rate well into double-digits, and will also include many fees for origination, underwriting, and as penalties for early payment of the loan. And at the end of the loan, a balloon payment will be required to ensure all principal, interest, and fees have been paid. Therefore, before signing up for a hard money loan, be sure you understand the terms of the deal, since the pressure will be on you to sell the property in time to pay off the loan.
When Should I Avoid a Hard Money Loan?
While a hard money loan can work in many situations, there are times when you are best served to look for other ways to finance your purchase. This usually involves if you are in a buyer’s market in your local area, meaning there are many properties that are not selling very fast. Since selling fast is key to making a hard money loan work for you, buying a property and still having it unsold when the loan comes due can spell problems for you and your investment. In many cases, you’ll either have to refinance or let the lender foreclose on the property. Either way, you will have lost a tremendous amount of money along the way.
If you have a solid plan in place when purchasing a property, securing a hard money loan can be quick, easy, and profitable for you and the lender, and can be the start to numerous successful real estate investment ventures.