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The majority of home buyers make use of traditional mortgage loans when purchasing real estate. However, there are some instances when quicker, private loans make more sense. This financing is known as hard money lending.
Hard money loans are short-term real estate loans made by private investors. They lend money based on the property value being used as collateral. These loans last from one to five years and come with much higher down payments and interest rates than conventional mortgages. They are intended to be repaid quickly by the resale of the property or with a refinance loan. However, because hard money lenders are mostly concerned with the value of the collateral, they are not as strict on credit standards and employment history. Hard money loans can be used on most types of property, including single- or multi-family residential, land, commercial or industrial.
There are several situations when a hard money loan could be the best fit:
For property investors looking to buy, renovate and resell homes quickly, hard money loans can be helpful. The loan can be made much quicker than a standard mortgage loan, allowing investors to purchase the property and get right to work. Most hard money loans can be approved in a day or two and funded in a week. Regular mortgages through banks and brokers can take between 30-45 days for funding. When a tight timeline is an issue, hard money can speed up the process.
Because hard money loans can close so quickly, they might give a buyer a competitive edge in a seller’s market. When there are multiple bids on a property, a seller may choose a buyer with a hard money loan because the sale can be complete in roughly a week and they can have their money quicker.
For buyers with recent bankruptcies, foreclosures or other major credit problems, a traditional bank loan is sometimes not an option. But if a buyer still has adequate income and a large enough down payment, a hard money lender may be willing to take a chance on him or her. Each loan is reviewed on an individual basis, not with a standard underwriting formula. This can mean more flexibility for borrowers.
Without full documentation or good credit, these real estate loans are riskier than bank loans. Interest rates are usually very high, somewhere between 10% -18% and buyers may be required to pay 2-5 points. And because the loan is based almost completely on the collateral value of the property, borrowers are at risk of having their home repossessed quickly if they default on the hard money loan.
Hard money lenders will look first at the value of the property. This could include their cost to resell it as well as the potential value of the home after any proposed renovations. Lenders also look at the loan-to-value ratio. They will require much lower ratios than traditional banks and lenders, somewhere between 50%-70%. This is to make sure they could sell the property quickly and recoup most of their money if the borrower defaults.
And while lenders are not overly concerned with borrower credit or unemployment history, they may ask about income and assets to get a general sense of the borrower’s financial ability to repay.
Finding a hard money lender takes a little more work than finding a traditional mortgage lender. Borrowers can start by searching online for local hard money investors or they can try going to local real estate investor group meetings. Hard money loans come easier when borrowers have networked and made some connections within the lending community.