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Depending on who you ask, hard money loans are either the easiest and best source of funding for real estate investors or nightmare loans of last resort.
Hard money loans are neither inherently good nor evil; they’re merely one financing tool among many in a real estate investor’s toolkit. Here’s what aspiring real estate investors need to know about hard money loans, including their pros, cons, costs, and the right and wrong times to use them.
What Is a Hard Money Loan?
A hard money loan is a collateral-oriented loan secured against real estate. Hard money lenders typically focus less on the borrower than conventional mortgage lenders, and more on the property and the quality of the deal itself. Instead of lending 90% to 95% of the value of the property like conventional mortgage lenders, hard money lenders typically allow a 60% to 80% loan-to-value ratio (LTV).
While hard money lenders do evaluate the borrower as well, their primary focus is making sure there’s enough equity in the property for them to recover their funds even if the borrower defaults. They scrutinize the deal to make sure the borrower is buying below market value and will be able to create even more equity by renovating the property profitably.
Hard money lenders are not major banks or corporations. Instead, they tend to be small, agile companies that operate on the local, state, or regional level. There are now a handful of nearly nationwide companies that offer hard money loans, but none that operate in all 50 states. Unlike banks, which try to serve a mass market, hard money lenders are niche lenders specializing in quick renovation loans for experienced real estate investors.
Hard money loans tend to be short-term (six to 24 months), interest-only, and available only for non-owner-occupied properties. By contrast, a mortgage tends to be borrower-oriented and long-term (15 to 30 years).
Conventional mortgage lenders scrutinize the borrower’s qualifications, such as credit history, income, debts, and ratios like debt-to-income ratio. The collateral – the https://paydayloanstennessee.com/cities/dyersburg/ property – only needs to appraise for at least the purchase price to satisfy conventional mortgage lenders.
Advantages of Hard Money Loans
Hard money loans have been around for a long time, and they’re still the funding option of choice for many real estate investors, despite the recent entry of “disruptors” in the field like real estate crowdfunding platforms. Here’s why hard money loans remain so popular among investors.
1. Speed and Flexibility
Hard money loans are fast and flexible, two qualities cherished by real estate investors. I’ve seen hard money loans close in three days from start to finish.
That speed is often necessary for real estate investors to secure exceptional deals by offering a quick and virtually guaranteed settlement to an anxious seller.
2. Ideal for Renovation Financing
Where hard money loans shine is renovation financing. Most hard money lenders cover 100% of the renovation costs and release the funds in a series of draws, based on a mutually agreed-upon draw schedule (more on this later).
Because hard money lenders focus more on the collateral property than the borrower, they don’t shy away from borrowers with bad credit. They just charge higher interest rates and fees, and lend at a lower LTV, to higher-risk borrowers.
4. Flexible About Down Payment
Another perk of hard money loans is that lenders often don’t care where your down payment comes from. You can borrow it from your Great Aunt Sue, pull a cash advance from your credit card, or sell your kidney on the Internet. Most hard money lenders don’t care because their focus lies in the collateral.
