When you think of a hard money lender, typically the image that cultivates in most people’s minds is that of a shady, alleyway-based dealer that keeps his hat down low and his interest rates high. He’ll give you all the money you want, but you’ll have to sign your life over as collateral.
In reality, hard money lenders serve a very specific niche of people, primarily those who deal exclusively with land sales. Since, by definition, hard money lending is simply a short-term loan that is secured by a real estate holding of some kind, typically the ones who utilize hard money lenders are real estate investors of some sort, usually those for whom traditional loans are inaccessible.
Hard money lending has three distinct advantages. First, it is usually quicker to secure a hard money loan due to the simplified application system. Collateral is usually all that’s required; most of the time, lenders don’t even look at a credit report. Second, there is more direct contact than traditional loans. Banks have several people that handle and have to sign off on loans, so the process can be confusing. Third, for people with a checkered financial past, it can easier to obtain financing by using collateral than by going off of a credit report.
Typically, the purposes that hard money lenders serve falls into one of five categories:
1. To Help People Flip Houses
Even though buying investment properties to resell has been an industry for hundreds of years, with the recent renaissance of television house-flipping shows, more and more people are aware of the great financial rewards that come with buying and reselling properties (unfortunately, many are also unaware of the risks).
For someone just starting out as a house flipper, it can be hard to secure start-up capital since their credit history is virtually non-existent. Moreover, the deals that are most advantageous to flipping usually arrive and exit the market in a short period of time, leaving the flipper almost no time to secure traditional financing. In this case, the speed and flexibility of hard money lenders are irreplaceable.
2. To Secure Loans for People With Bad Credit
Most lenders never even consider a borrower’s credit report, much less perform any income verifications or investigate foreclosures and bankruptcy proceedings, which means that someone who is unable to secure a loan for their real estate project may have no other option but to use a hard money lender. While the interest rates are high and the risk may be great, hard money loans allow the investor to obtain working capital to grow their business without the fear of being rejected after a lengthy wait.
3. To Bridge the Gap In Building Projects
Show me a construction or flipping project that goes according to plan, and I’ll show you a beachfront property in Northern Kansas that is right up your alley. They simply don’t exist. With only a few minor exceptions, nearly every property transaction or rebuilding project that is undergone by investors comes with at least one hiccup, and in many cases, several.
While this can be frustrating for investors, for some, it can be devastating. The longer a project goes and drifts behind schedule, the more money it can cost the borrower. Hard money lenders can offer money that helps to bridge the gap between expected completion date and actual completion date since many lenders are real estate investors themselves. The rates may be higher than traditional loans, but the short-term contracts that many hard money lenders offer are perfect for someone that needs additional capital for a few extra months.
4. To Provide Capital to People Banks Won’t
Not only are people with bad credit subject to rejection by traditional banks, but also people with no credit as well, including foreign nationals who are not U.S. citizens. Since virtually anyone with any amount of capital can act as a hard money lender, all it takes is one person to say no, whereas several people at financial institutions have to say yes, if the laws allow them to at all. For people with no credit, or for those who the law will not allow banks to lend to, hard money lenders can be a lifesaver.
5. Because of Alternative Motivations Besides Money
Though hard money lenders generally loan out their money in order to receive money via interest rate or defaulting on their loan, they may also have a particular passion for the project at hand and have a desire to see it finished. Moreover, if they see a way to partner with the investor on additional projects or cooperation with their own, they may lend out the money in order to help the other business grow. Hard money lenders are not bound by the same motivations as traditional lenders and have the freedom to lend for whatever purpose they deem necessary.