Your primary experience with real estate lending up until this point may be with traditional banks and credit unions. If you are now thinking about applying for a hard money loan, be aware that hard money loan terms are substantially different than the loan terms offered by banks and credit unions. Remember that hard money lenders are private companies or individual investors who are lending their own funds. While some applicants use hard money loans as a temporary financing solution when they need a fast closing, many others use hard money loans because they have a loan request that a bank will not approve. In many cases, these loans are seen as too risky for a traditional bank.
Because of these important factors, you can generally expect hard money loan terms be significantly different than bank loan terms. Hard money lenders review each loan request on a case-by-case basis. They review all strengths and weaknesses of a loan request to make a decision about how risky it is. In addition, they want to determine if there is substantial upside to the transaction. Hard money loans can be used for residential and commercial properties as well as for development or construction in some cases. They can also be used for rehabilitation or renovation projects as well as for funding while occupancy stabilizes, repositioning related to new property management and more. Because each hard money loan is unique and each lender analyzes loan requests differently, each set of loan terms on an approved hard money loan will be customized specifically to the scenario.
While lending terms for hard money loans across the board are customized based on the scenario, keep in mind that most hard money loans have a low loan-to-value. For example, on a commercial hard money loan, it is common for the loan to value to be 60 percent or less of the sales price or property value. This means that a buyer using a hard money loan would have to pay at least 40 percent down as well as closing costs. Closing costs on a hard money loan can be expensive in comparison to traditional bank loans. Keep in mind that each hard money lender may have specific property types that it lenders on as well as maximum loan-to-value limits for each property type.
Interest rates on bank loans vary based on the property type, the use of funds, the borrower’s credit score, the loan-to-value and other factors. These same factors can affect the interest rate on a hard money loan, but hard money lenders do not have a pre-established pricing sheet that they use to determine interest rates. In many cases, lenders analyze the specific factors of a loan request. The interest rate is tailored to meet the specific circumstances for the scenario. However, expect the interest rate to be substantially higher than the rate for a bank loan.
Interest rates for hard money loans may be fixed or adjustable for the term of the loan. Fixed rates are more common with shorter term lengths, but this is not always the case. When applying for a hard money loan with an adjustable interest rate, pay attention to the maximum interest rate that can be charged in a worst-case scenario to ensure that the loan would still be affordable.
Another important factor to consider when applying for a hard money loan is the loan term. Most traditional bank loans have a very long term and are fully-amortizing. For example, a fully-amortized 30-year loan is common for a residential loan from a bank. This means that the loan payments will be spread out over 30 years and that the entire loan balance will be repaid at the end of that 30-year period. Most hard money loans have a very short term, such as between 12 and 18 months. The loan typically has a balloon payment, and this means that the borrower needs to have an exit strategy for the loan. Most hard money loans are either extended through the hard money lender or refinanced into a permanent bank loan. In some cases, the loan is paid off when the property owner sells the property.
Remember that these are general guidelines for hard money loan terms. Each lender has its unique way to price loans, and each loan is individually reviewed by lenders. This means that you typically must contact multiple lenders with specific information about your loan request in order to obtain a personalized quote for your loan request. Before formally submitting an application or loan request package, it is helpful to contact a lender’s representative by phone to discuss your scenario. This can help you to avoid wasting time submitting a loan request to a lender who may not be able to help you.