There was a time when unethical companies would intentionally charge outrageous fees and interest so they could foreclose on a real estate investment. Today, hard money lenders enjoy a better reputation since many new investors now recognize the role these loans play in the housing industry. To help new investors better understand how hard money loans work, this guide will cover the basics behind these loans and where to find this type of financing.
Explaining Hard Money Loans
Hard money loans are short-term financing with terms that are typically three years or less. The average term on these loans is 12 months. Instead of receiving funds directly from traditional banks, the funds come from private investors or companies that specialize in hard money financing. The real estate behind the investment is what lenders use as collateral for the loan.
Most banks lend borrowers money based on their ability to repay a mortgage. Hard money lenders offer loan amounts based on the value of the investment. In many cases, hard money loans are determined by the after-repair value of a home.
Borrowers must make monthly payments while there is an outstanding loan balance. However, most lenders only require borrowers to make monthly interest payments until the property is ready to sell. Once the borrower lists the property, hard money lenders require a balloon payment to pay off the principal balance of the loan.
Best Properties for Hard Money Loans
These loans are not for borrowers trying to buy a primary residence. Traditionally, hard money loans are for real estate investors who want to fix a property and sell it fast. The loans are popular among investors since banks typically do not lend money for investment purposes. If they do, it can take weeks or months for investors to receive the funds from the loan.
Investors use hard money financing to buy single-family homes, condos, multi-unit properties and townhomes. Sometimes people use these loans for land transactions such as buying a mobile home park in need of renovations. Investors also buy commercial and retail properties using these loans. A hard money lender will fund any real estate transaction as long as the deal makes sense, so there is no limit to what type of investment property someone can buy.
When to Use Hard Money Loans
When investors want to act fast on a real estate deal quickly, they often turn to hard money financing. Many times these loans fund within in a week or less, which gives an investor a chance to act quickly on a deal with several competing offers. When an investor receives an approval, they can present an all-cash offer that may stand out among sellers. If an investor relies on bank financing to act on a deal, they may have to wait 30-45 days before they receive the funds. By the time the funds arrive, a good deal with multiple offers is probably long gone.
When Not to Use a Hard Money Loan
A potential homebuyer with good credit, a big down payment and a solid income history should stick with a traditional mortgage. Hard money financing is not an ideal loan option for someone who wants to buy a primary residence. When compared to hard money loans, traditional mortgages offer far lower interest rates, fees and much longer loan terms.