Hard money loans have become increasingly common over the past few years. Despite this rise in popularity, many people don’t know what they are or how they can take advantage of them. Those that are familiar with the term may also not realize the full extent of their potential.
This lack of understanding includes the potential drawbacks that can be associated with a hard money loan. Because of the financial implications of the loan, especially if it is not paid back on time, it’s worth taking the time to learn what hard money loans are and how they work.
Furthermore, it’s worth considering where and when these kinds of loans may be appropriate, and when you should steer clear of them.
What is a Hard Money Loan, Exactly?
Hard money loans are generally used to help finance real estate transactions and are typically seen as a last resort in the short-term financing world. In this sense, they’re usually awarded based on the value of a property instead of the creditworthiness of those borrowing the funds.
In contrast to many other options, hard money loans are primarily given by private lenders instead of banks. This is because they’re normally seen as a riskier investment than other loans and therefore many financial institutions aim to avoid them.
The risk involved for the lender in hard money loans means the cost of borrowing is much higher than other options. This is especially true when compared to many federally-funded programs, although there is also a notable difference between hard money and other loan options provided by banks.
Despite the increased cost, these loans typically come with a faster approval rate and can often be accessed by people who may be ineligible for other loans. This means that they can commonly be used by people who have a poor credit history and need a quick turnaround with their finances.
What are the Benefits?
There are a variety of benefits to using this type of loan, which is why they have proven to be so popular in recent years. One of the most obvious reasons is that these funds can be much easier to borrow than many other options.
This is because the approval process is much simpler and doesn’t factor in many aspects that may have excluded certain borrowers. In many cases, a lender will look at the value of an investment rather than the creditworthiness of those looking to receive the funds. As a result, many people who were previously excluded will be able to receive a loan.
The focus on collateral also means that the borrowing process will often be much faster than it is with typical loans. Speed has often meant that hard money is the go-to option for house-flippers and other borrowers who need quick cash and who can pay it back quickly.
The majority of these lenders also don’t need to go through the process of reviewing bank statements, verifying income, and many other traditional aspects of the borrowing process. This helps to speed up the loan approval significantly.
Many of these loans also offer much more flexibility than mortgages and other loans. This is because lenders don’t use the same standardized underwriting process as banks and other financial institutions. In contrast, they base many of their decisions on a case-by-case situation and look at each potential borrower individually.
This ability to individualize loans can provide a variety of other benefits. One of the most notable is that lenders will work with each client to tweak payment schedules as needed. This is because the majority of them aren’t restricted by institutional policies that treat every borrower the same.
Lenders don’t want to repossess the assets that they’ve helped pay for and then sell them to recoup their money, as it means there could be a significant amount of time and hassle involved. As a result, they’ll aim to avoid this as much as possible and work with each client to prevent it. That flexibility can be a considerable advantage for people who may struggle to pay back the loan.
What are the Drawbacks?
Like many other financial decisions, there can be a variety of drawbacks to hard money loans. One of the largest of these is the cost that’s associated with them. While these may seem like a more affordable solution to other options, this is often because they’re much more short-term than mortgages and others.
Currently, hard money typically charge anywhere between 7.5% and 15% on any loan, with many often charging much more than this. Contrast this with subprime loans, which are generally seen as one of the more expensive options, charging an average of 5.5% interest.
Interest rates can be dependent on the length of the loan you receive. It’s been noted that the shorter amount of time you’ll pay the loan back over, the higher the interest rate will be.
Alongside this is the fact that you may need to pay several fees up front when taking the funding. While these may initially seem small, they can quickly add up, especially when added to the interest that you’ll have to pay back.
There’s also the fact that some lenders may elect not to provide financing to people who live in owner-occupied housing. Much of this is driven by the oversight and regulation that’s aimed at this sphere. This may make it difficult for many people who are buying a home to live in to receive a hard money loan.
Many of these loans also offer a smaller loan-to-value ratio (LTV) when compared to other options. With mortgages, for example, you can typically expect to receive anywhere between 50% and 80% of a house’s value to purchase it. Hard money will offer much less than this. While this mightn’t be an issue for people who need only a small amount of funds, it can be an issue for those of us who need to borrow the majority of the price of the property.
There is a certain amount of oversight in this lending niche, but there’s not as much when compared to mortgages and other loans. Though this means that many of us who are ineligible for other short-term financing will be able to qualify here, other borrowers might find it off-putting.
Taking out any kind of loan has its risks, which means you should make sure that it’s necessary that you do so before you get one. There are a variety of other things that you’ll need to consider when taking one out, such as interest rates and other variables.
Each of these will apply to hard money loans, which can often be riskier than their traditional counterparts. You’ll need to pay particular attention to the terms one before you sign any contracts.
Finances can often be one of the most challenging parts of life for any of us to look after. It can be quite easy to make a mistake that could lead to large consequences. The most important aspect of the hard money loan process, similar to any other loan, is to put a significant amount of research into who you’re borrowing from.
Alongside this is the fact that you’ll need to ensure that you’re only borrowing as much as you can afford to pay back. By doing so, you should avoid any financial complications in the future. While these types of loans can often be a quick and easy way to solve short-term problems, they can cause issues in the future if not looked after.
Keeping a keen and informed eye on what you agree to will play a large role in your successful outcome. By doing so, you’ll be in the best position possible to make a decision about whether this is the right loan for you.