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Hard money loans are often used by real estate investors to fund their projects when they are unable to obtain a traditional bank loan. While it would be great if traditional bank loans were fast and easy to obtain, that’s just not the case. If you have had questions about hard money loans and wondered if they are an option that you should consider, keep reading to learn more about this mortgage loan product.
About Hard Money Loans
Hard money loans are asset-based real estate loans. Lending decisions are based on the value of your collateral, unlike traditional bank loans that focus on income and credit in order to assess your ability to repay the loan. Hard money lenders are private investors that fund loans using different criteria than traditional bank lenders. They assess loans based on each application as opposed to following strict standards and requirements.
Types of Hard Money Loans
Construction loans provide developers a chance to start a new construction project when they intend to refinance or sell it right away. Fix-and-flip loans are for the purpose of buying and fixing up a rehab, then reselling and paying the loan off. Bridge loans enable you to purchase a property fast, then resell or finance it. A bridge loan can also be used to buy a new property before getting the cash for a down payment by selling a property that you currently own.
The less common owner-occupied loan is provided by some hard money lenders, but many shy away from consumer loans because of the additional regulations that are involved, such as Dodd-Frank.
How Hard Money Loans Work
An easy application process and a fast turnaround time are some of the perks of hard money loans. The lending process can take less than a week, which is a very attractive feature of hard money loans. There’s a good chance that you will need a cash down payment that’s based on the Loan-To-Value (LTV) ratio or the After-Repair-Value (ARV) ratio.
The term of hard money loans is 12 months to a few years. Instead of making equal principal and interest payments each month, borrowers of hard money loans will usually pay interest only payments. There might even be an option to make zero payments until the maturity date, at which time you will make a balloon payment. The balloon payment will require you to pay the entire principal, the remaining interest and all fees.
Is a Hard Money Loan Right for You?
In order to decide if a hard money loan is right for you, it’s important to understand the pros and cons. Let’s first review the benefits of a hard money loan. For starters, you have access to money fast, often within a week. The terms are flexible and requirements for approval are far more lenient than a traditional bank loan. All of these characteristics mean you are more likely to have the financial resources that you need to invest in real estate.
On the flip side, there are aspects of hard money loans that you should consider carefully. Hard money loans are for a very short term, they have high interest rates, there are a variety of fees that can be added and there is limited government oversight. Another issue is that the short term nature of the loan means you could have a problem refinancing because of traditional mortgage lender requirements. Specifically, there is usually what’s called a “seasoning” period, which means you have to hold the loan for a certain period of time before you can refinance.
Quite frankly, many real estate investors view hard money loans as a tool that allows them to take advantage of more investment opportunities.
Once a real estate investor discovers a property they wish to purchase, they want to complete the transaction as soon as possible. However, if they pursue a traditional mortgage through a bank, gaining financing may take several weeks. Rather than go through this time-consuming process, many investors rely on hard money loans to get that perfect piece of property. But since hard money loans differ from traditional mortgages, knowing the details associated with these loans is very important before committing to this form of financing.
When an investor pursues a hard money loan, it may be for a variety of different projects. For some investors, the loan will be used for a fix-and-flip project, where they will purchase a property, quickly make the necessary repairs, and then sell it for a profit, enabling them to pay off the loan. For others, it may be used to purchase a property to start a business, or perhaps a construction project. Whatever the case may be, since these loans are provided by private individuals and institutions, each investor’s case is considered case-by-case, making these loans suitable for many investment options.
Repaying the Loan
Unlike mortgages where the bank assesses a person’s ability to pay back the loan, the lender of a hard money loan is concerned much more about the value of the property to be purchased, since it will be used as collateral for the loan. Along with this, the payments made on a hard money loan will not be monthly payments of equal value applied toward the principal. Instead, the investor will make interest-only payments, with a balloon payment at the end to pay off any remaining principal, interest, and fees. Also, it is important to note that while a mortgage has a payback period of anywhere from 15-30 years, hard money loans often have payback periods of no more than three years.
Have Your Own Money
While a hard money loan will typically provide an amount equal to as much as 90 percent of the property’s value, it will rarely if ever give an investor the full amount to purchase a property. Because of this, any investor preparing to use a hard money loan must be prepared to have 10-20 percent of the property’s value ready as upfront money. In most cases, the lender will look at the property’s loan-to-value ratio or after-repair ratio, which will let them determine how much money they will lend toward purchasing the property.
Past Financial Problems
If an investor who has had past financial problems with bad credit or bankruptcies attempts to secure a mortgage at a bank, they are most likely wasting their time. However, if pursuing a hard money loan, the lender cares little about these or other financial problems from the investor’s past, since they are in a win-win situation. For the lender, either the loan is paid off on time, is refinanced at a higher interest rate, or they foreclose on the investor and take ownership of the property. However, since past problems are not an issue in securing hard money loans, investors can gain these loans very quickly, often in less than one week.
Finding Hard Money Loan Lenders
For investors who have never used a hard money loan to purchase property, one of their biggest obstacles is finding a lender who specializes in these loans. But while this may sound difficult, it is often much easier than most people realize to find a source of local hard money loans. In most cases, simply asking other investors or real estate professionals will usually lead to many sources of these loans. In many places, chances are numerous investors are using this method of financing, so finding a local lender should be no problem.