Pros and Cons of Hard Money Loans
Hard money loans, also known as fix and flip loans, are short-term real estate loans usually borrowed without using traditional mortgage institutions. Borrowers intend to use the proceeds to build, repair or renovate a house before selling it for a profit, part of which is used to repay the loan. Hard money loans are provided by individuals or professional real estate investors and have a payback period of one to five years.
How Do Hard Money Loans Work?
Unlike traditional mortgage lenders who focus on your credit history before approving a loan, hard money lenders are less concerned with your financial status. Lenders use the value of the home you intend to buy to determine the amount you are eligible to borrow and use it as collateral. In the event you are unable to repay the loan, the home is sold to recover the borrowed funds.
Before taking out a hard money loan, it is crucial that you learn about their pros and cons. Getting ahead of the game instead of going in blind will go a long way to ensure the success of your investment.
Pros of Hard Money Loans
Easier to Qualify
Hard money loans are more accessible to borrowers compared to traditional loans. Most hard money lenders do not scrutinize a borrower’s eligibility requirements such as credit score and income level but only need the home as collateral.
This feature enables borrowers with a poor credit history or self-employed people to be eligible for hard money loans.
Unlike traditional lenders who require borrowers to possess real estate experience to approve a loan, hard money lenders do not need any prior industry knowledge. Even if you are a beginner investor in the house flipping business, you are eligible to borrow a hard money loan.
Quicker Approvals and Funding
Since hard money lenders are only interested in the home as collateral, the credit approval takes less time. Traditional lending institutions require you to provide a mountain of paperwork that often takes a lot of time to scrutinize thereby delaying the loan approval process.
Hard money lenders only require you to provide the documents of the property you intend to buy to determine the amount you are eligible to borrow and then give you the funds. While traditional lenders approval may take up to seven days, hard money lenders can approve and provide the money within 24 hours.
Since private investors provide hard money loans, the terms and conditions of an agreement are negotiable. Unlike the traditional lenders with strict borrowing policies, hard money lenders do not have a standard underwriting process and evaluate every borrower individually. Depending on your situation and negotiation skills, you may be able to tweak some terms of the agreement in your favor provided the lender conforms.
Personalized terms and conditions such as repayment schedules and loan fees might enable you to minimize the probability of default. If you are a regular borrower, you might convince your lender to provide a higher loan amount to flip more than one house. Multiple house flipping will result in higher profits.
Cons of Hard Money Loans
Higher Down Payment
Hard money loans require borrowers to provide a down payment which is a percentage of the total credit line. However, the equity requirement in hard money loans is quite high compared to traditional loans. While the conventional lenders consider your credit score to determine the down payment, hard money lenders require you to provide 25 to 30 percent equity of the loan approved.
Higher Loan Costs
The interest rates charged by hard money lenders are very high compared to traditional lenders. Since lenders do not look into the financial status of a borrower before approving a loan request, this is considered a high-risk level which is countered by imposing a higher interest rate. Hard money loan rates often range from 9 to 14 percent.
Also, hard money borrowers are required to pay an extra fee for the loan referred to as points which is a percentage of the total loan approved. The points may fall anywhere between two and four depending on the lender.
Shorter Payback Period
Hard money loans have a shorter payback period compared to traditional loans. The payback period depends on the lender but majority fall between one and two years. Some lenders allow borrowers to repay the loan in three to five years, but the number is limited.
An extended payback period is riskier for a lender because of changes in prevailing interest rates. In the event interest rates decrease, borrowers may opt to refinance the loan at the lower interest rate. If the interest rates increase, borrowers continue repaying the loan at the initial interest rate. Both scenarios negatively affect the lender’s profit forcing them to reduce the payback period.