If your loan request has recently been declined by a lender or if you cannot find a lender who will even look at your loan request, hard money may be right for you. While banks, credit unions and other financial institutions typically have a very tight box of parameters that a loan request must fall into for approval, hard money lenders look at all of those other great deals that do not fit into that tiny box. There are many highly lucrative real estate deals involving development, renovations, rehabilitation and more, but funding is required to get those deals moving forward.
Before you apply for a hard money loan, you understandably want to know what loan terms to expect. Each loan request is priced individually based on the lender’s review of the scenario. Generally, you can expect a substantially higher interest rate than what you will find with traditional residential and commercial loans. However, because these real estate deals can be so lucrative with the right funding, the higher interest rate is not usually a major factor. Nonetheless, you also need to be aware of the other loan terms that you can reasonably expect to receive.
The term length essentially is how long the loan will remain in place. Hard money loans are short-term real estate loans. Most have a term of approximately 12 months, but there is variation to this. In addition, some loans have the option to be renewed or extended for several additional years. If your loan request is based on a specific property turnaround scenario, such as a rehabilitation or some other situation, the lender may be willing to work with your timeline. For example, you may need six months to rehab the property plus another nine months to bring the property up to full occupancy and to stabilize the income level. You may not be able to qualify for a permanent takeout loan until this happens. In addition, you may need another three months after stabilization in order to walk through the traditional loan process. With this in mind, you may reasonably ask a lender to provide you with a hard money term length of 18 to 24 months.
Remember that hard money loans are customized to the specific loan request. Some investors are only comfortable lending money for a nine to 12-month period, and these may not be the right hard money lenders to turn to for all situations. Others are far more flexible. Remember that hard money lenders and private investors are investing their own funds into your project. They may have other plans in mind for their funds in a year or two. It is wise to determine the ideal term length that you need before speaking to hard money lenders. Be up-front about the desired loan term so that you can find the right hard money lender to work with.
While the term length is how long the loan remains in place, the amortization period describes how the debt is paid off over time. A fully-amortized, 30-year loan is common with a residential loan on an owner-occupied home. This means that you will make 30 years of monthly loan payments, and at the end of the 30-year period, the loan balance will be fully repaid. A hard money loan does not work in this way.
Typically, a hard money loan is an interest-only loan, or it may have a very large balloon payment due at the end of the loan term. Therefore, while the interest rate on a hard money loan may be higher than what is offered by traditional lenders, the loan payments are typically rather affordable. While it is important to understand what the monthly loan payment will be for your hard money loan, it is also important to understand if the payment includes only interest charges or if a portion of the principle will also be repaid.
Fixed or Adjustable Rate
Another factor to consider is if the interest rate is fixed or adjustable. A fixed rate is not common with hard money loans, but it can be desirable for many applicants. This is because it ensures a stable payment amount throughout the life of the loan. An adjustable rate is more common. Both the index and the spread for an adjustable rate can vary from lender to lender. If your lender offers an adjustable rate, pay attention to the floor and ceiling. Always ensure that you can afford to pay the adjustable rate if the rate skyrockets to the maximum level allowed per the loan terms.
Some applicants are so thrilled to have found a lender who will extend them a loan that they fail to analyze loan terms or to compare offers. Always verify that the loan terms offered to you are suitable for your plans. If not, consider negotiating terms or shopping around.