If you find a promising property to flip but traditional lenders won't approve a loan in time, a hard money loan may be your best option. Hard money loans are short-term loans secured by real estate, often used by investors who need quick funding. MoneyGeek breaks down everything you need to know about these loans, from how they work to their pros and cons to where you can find hard money lenders for your next investment.
Hard Money Loans: What Are They and How Do They Work
Updated: October 19, 2024
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Key Takeaways
Also called bridge loans, hard money loans are short-term, asset-based loans secured by real property. Real estate investors commonly use them for quick financing.
While hard money loans offer benefits like fast approval and flexible terms, they have drawbacks such as higher interest rates, shorter repayment terms and the risk of losing the property if the borrower defaults.
Hard money loans are offered by private real estate investors, equity companies and asset-based lenders rather than traditional banks or credit unions. These lenders focus primarily on the property's value rather than the borrower's credit.
What Are Hard Money Loans?
Hard money loans, also called bridge loans, are short-term loans secured by real property. The "hard" in "hard money" refers to the tangible asset backing the loan's value. If a borrower defaults on a hard money loan, the lender can take ownership of the property to cover the losses.
Hard money loans often come with higher interest rates and fees than traditional loans due to their short-term nature and the risks involved. They are typically used by investors or borrowers who need quick financing. The approval process is fast, with fewer qualification requirements, giving you access to money when you need it.
How Do Hard Money Loans Work?
Hard money loans are considered loans of "last resort" because they are often used when traditional financing is not an option due to time constraints, credit issues or the risky nature of the project. As such, traditional lenders usually don't offer these loans.
The loan amount is typically based on the property's value as collateral rather than the borrower's creditworthiness. This makes the approval process faster and less stringent. Hard money loans are ideal for those who need to close deals quickly, as approval can happen within days.
The terms of hard money loans are usually short, ranging from six months to a few years. They have higher interest rates and fees than traditional loans. Some lenders may offer interest-only payments during the loan period, with a balloon payment required.
If the borrower defaults, the lender can seize the property used as collateral to recover the loan. This structure allows hard money lenders to mitigate their risk while providing borrowers with quick access to funds.
Common Uses of Hard Money Loans
Hard money loans are ideal for situations where traditional financing may not be available or practical due to time constraints or project risks. Here are some of their common uses:
Flipping a house
Real estate investors often use hard money loans to purchase and renovate properties quickly. These loans allow them to secure the property and begin renovations without waiting for traditional loan approvals. Once the property is flipped and sold, the investor can pay off the loan.
Purchasing investment property
Investors use hard money loans to buy rental properties or other types of investment real estate. This allows them to secure the property quickly, even if they have poor credit or need fast financing. The loan provides investors the flexibility to act on opportunities without delay.
Financing a commercial property
Hard money loans can finance commercial real estate, especially when traditional lenders won’t approve the loan. Borrowers can use the loan to acquire the property and develop or improve it for future revenue. Commercial investors benefit from the quick access to funds that hard money loans provide, which is especially useful for time-sensitive deals.
Avoiding foreclosure
Homeowners facing foreclosure may turn to hard money loans as a last resort to prevent losing their property. These loans provide fast relief by helping borrowers catch up on missed payments or pay off the existing mortgage. The homeowner can then work to stabilize their finances or find more permanent solutions.
Pros and Cons of Hard Money Loans
Hard money loans offer quick access to funds but come with higher costs and risks. Knowing the pros and cons can help you decide if a hard money loan fits your specific situation and financial goals.
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Where to Find Hard Money Lenders
Credit unions and banks don't offer hard money loans due to their high-risk nature. To find hard money lenders, you'll need to turn to private real estate investors, real estate investment companies, equity companies and asset-based lenders.
When looking for reliable hard money lenders, consider the following tips:
Get a referral: Ask fellow real estate investors or professionals for referrals to trustworthy hard money lenders. A referral can provide valuable insight into the lender's reliability and terms.
Talk to a title office: Title companies frequently work with hard money lenders and can provide you with a list of reputable options. They have experience handling transactions with various lenders and can offer helpful suggestions.
Search online: Research hard money lenders online and compare their services, rates and reviews. Be sure to focus on lenders who specialize in the type of real estate project you are financing.
How to Get a Hard Money Loan
Getting a hard money loan is usually quicker than obtaining traditional financing, but it's still important to follow the necessary steps to ensure you meet the requirements and secure favorable terms.
- 1
Identify your financing needs
Start by clearly defining your project and how much financing you need. Determine the property's value, your estimated timeline and how much you can afford to make a down payment. Having a detailed plan will help you communicate your needs to potential lenders.
- 2
Choose a hard money lender
Research hard money lenders that specialize in your type of project. Compare their terms, rates and reputation by reading reviews, asking for referrals or consulting a real estate professional. Once you’ve found a few options, reach out to discuss your project and see who offers the best fit.
- 3
Submit your loan application
Prepare and submit a loan application to your chosen lender. This usually includes details about the property, your project plan and your experience in real estate, if applicable. Be ready to provide documents like property appraisals, financial statements and any other information the lender requires.
- 4
Negotiate the loan terms
After your application is reviewed, the lender will offer terms for the loan. Review the interest rates, fees, repayment schedule and any conditions attached to the loan. Don’t hesitate to negotiate terms if you believe better options are available, and make sure you understand all the details before proceeding.
- 5
Get an appraisal and inspection
The lender will usually require an appraisal and inspection of the property to confirm its value and condition. This step helps the lender assess the risk and finalize the loan amount. Ensure the property meets the lender’s requirements to move forward with the loan.
- 6
Close the loan
Once all the terms are agreed upon and the property is appraised, the closing process begins. During closing, you will sign the necessary documents, pay any upfront fees and finalize the loan. After closing, the funds will be released, allowing you to proceed with your project.
Alternatives to Hard Money Loans
Hard money loans aren’t the only option for quick financing in real estate. If you need funding but prefer alternatives, there are several other routes to consider, including:
Private money loan
Private money loans are typically provided by individuals, such as family members or friends, rather than traditional lenders. These loans often come with more flexible terms based on personal relationships and trust, allowing borrowers to negotiate terms that may suit their needs better than hard money loans. However, borrowing from family or friends can create tension if repayment issues arise, so it's essential to have clear, written agreements in place.
Home equity line of credit (HELOC)
A home equity line of credit (HELOC) allows homeowners to borrow against the equity in their home. This option usually offers lower interest rates than hard money loans and can be used for various purposes, including financing real estate projects. However, you risk your home if you’re unable to repay the loan, as the property is used as collateral.
Government-backed loan programs
Programs like FHA loans or VA loans provide government-backed financing options, typically at lower interest rates and more favorable terms. These programs are designed to help certain borrowers, such as first-time homebuyers or veterans. They usually take longer to process than hard money loans, so they're best for situations that don't require immediate funding.
Cash-out refinancing
Cash-out refinancing allows you to replace your current mortgage with a new one and withdraw some of the equity as cash. This option can offer lower interest rates than hard money loans and longer repayment terms. However, the approval process can take time, and you increase your mortgage balance by taking cash out of the property.
FAQ: Hard Money Loans
We compiled a list of frequently asked questions about hard money loans to help you decide if this is the best option for your particular needs.
Who typically uses hard money loans?
Hard money loans are commonly used by real estate investors, house flippers and developers who need quick financing. These borrowers often require fast funding to close deals or finance renovations and may not meet the criteria for conventional loans. Borrowers with credit issues but possess valuable property as collateral also use hard money loans.
What are the interest rates on hard money loans?
Interest rates on hard money loans are significantly higher than those on conventional loans, often ranging from 8% to 15%, as lenders consider them to be riskier.
What are the typical terms of a hard money loan?
Hard money loans are short-term by nature, typically lasting anywhere from six months to a few years.
What are the risks of hard money loans?
The primary risks of hard money loans are high interest rates and the potential for losing the property if the borrower defaults. Also, hard money loans come with higher fees, making them costly if the project doesn’t go as planned.
How is the loan amount determined for hard money loans?
The loan amount is typically determined by the property's value as collateral. Most hard money lenders offer loans with a loan-to-value (LTV) ratio of 60 to 70%, meaning borrowers can expect to receive a loan that covers up to 60-70% of the property's appraised value. In some cases, lenders may also consider the borrower's plans for the property, such as the after-repair value (ARV) if renovations are planned.
Can I get a hard money loan with bad credit?
Yes, borrowers can often obtain hard money loans with bad credit. Unlike traditional lenders, hard money lenders focus more on the value of the collateral than on the borrower’s credit history. However, having poor credit may result in higher interest rates or more stringent loan terms.
About Zachary Romeo, CBCA
Zachary Romeo is a certified Commercial Banking and Credit Analyst (CBCA), and the Head of Loans and Banking at MoneyGeek. Previously, he led production teams for some of the largest online informational resources in higher education, with over 13 years of experience in editorial production.
Romeo has a bachelor's degree in biological engineering from Cornell University. He geeks out on minimizing personal debt and helping others do the same through people-first content.
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