What is hard money? This is a frequent question for many borrowers who are locked out of traditional real estate financing. “Hard” is one of the last things anyone expects to hear as a description of money. Upon further analysis, the term hard money is actually apt because money doesn’t grow on trees and can be very hard to earn. Unless you’re an heir to billions, then you probably belong to the working class who works hard for your money.
What Exactly is Hard Money?
The term hard money is finance terminology used to refer to money that is loaned for a specific purpose under a stringent set of circumstances. As with any loan, the point of getting this hard money is to use it to fund something, with the agreement to pay the money back.
Some people say it is called hard money because it is harder to pay back. Hard money can be easily acquired because it doesn’t require the usual documentation that banks ask for, but it comes with steep interest rates that reach double digits. On top of that, it comes with very short terms, ranging from one to five years maximum.
Imagine borrowing a certain amount of money and feeling the pressure to pay it all back quickly, along with a lot of interest. That scenario is hard and difficult, as it exerts stress on you to make ends meet while paying for the loan at the same time. Talk about a double whammy!
What are the Specifics of a Hard Money Loan?
A hard money loan is a simple short-term loan that is funded by a private lending house or a private investor. These loans are easily approved because they are secured by real estate collateral. Unlike banks, credit unions, and other financial institutions that ask for a lot of documentary requirements, including your stellar credit history, these hard money loans just examine the collateral. So, if you have a less-than- ideal credit history, you might consider this type of private loan.
Take note that the amount of money lenders are able to let you borrow is based on the value of the property. This property can be either what the borrower already owns, as long as it has sufficient equity, or what the borrower is still hoping to acquire. This kind of hard money loan requires monthly payments of only interest, or interest with some principal, or a balloon payment at the end of the loan agreement.
Hard money lenders go with the collateral’s property value over the borrower’s credit history, although the latter is still considered by some lenders. Borrowers don’t have to jump through hoops to gather their documentation and wait for approval, which is the typical scenario in most traditional loans.
Hard money loans are typically used in real estate investments, where you need the money quickly to take advantage of a good deal on a nicely-priced property. The payment terms remain short compared to a traditional mortgage because the idea is not to dwell in the property but to sell it quickly for a handsome profit. The procedures to get the loan aren’t so meticulous, which raises the risk for the lender, so the interest rate of the loan is high. Remember, when banks and other financial institutions refuse you, these life-saving, hard money lenders can still say “yes.”
What are the Ideal Property Types for Hard Money Loans?
A prospective borrower can ask for a loan against any type of property, including single detached, family residential, multi-family dwelling, commercial, raw land, and industrial. Most hard money lenders specialize in a niche. This means they only lend against one type of property, so if their niche is single-family abodes, don’t expect them to view your commercial application.
It makes a lot more sense for them to specialize and master one specific type of transaction. They don’t refuse other transactions because the borrowers are lacking in requirements, but because they themselves do not have expertise in the niche market the borrower is entering. Thus, it is vital for you to ask your hard money lender about their preferred niche before you hand in your personal information and property details.
What Types of Real Estate Should Hard Money Loans be Used For?
Keep in mind that hard money loans are not appropriate for all types of real estate transactions. If you are purchasing your primary home, and you have a good credit standing, possess a stellar income history, and bear no foreclosures to your name, then going through a traditional bank loan is the better choice because of the lower interest rates and longer terms. Hard money could be your source of financing when banks are not an option, for deals such as:
- House fixing for immediate flipping that needs quick cash
- Borrowing to buy land that has many bids and you want to stand out
- Loans for construction building
- When you have credit issues
- When the seller wants a quick sale
Who are the Perfect Clients for a Hard Money Loan?
Real estate investors rely on hard money loans for a variety of reasons. The primary reason is the capability of lenders to fund loans at a fast pace: in fact, the loan can often be funded within a week. Compare that to the month or month-and-a-half processing from the bank. These hard money loans can get you the money swiftly and with fewer requirements. Processing for hard money loans can take a day or two, with the approval notice coming on the same day, and the money before the week is out.
This ease of getting the cash is very helpful for keeping real estate investors on top of their A-game. Sometimes, properties have many competing bids, so a quick sale is a primary goal. Having cold, hard cash to offset an offer will set the buyer apart from the rest of the pack.
Another reason people rely on hard money loans is they have been rejected by a bank or finance institution for a traditional loan. With credit issues and foreclosures, banks are really poised to reject these risky prospects. In some instances, the bank might say a person doesn’t have a sufficient income history even if the figures are healthy.
Hard money lenders can easily look past these issues as long as the borrower has sufficient funds to make the loan payments and has sufficient equity invested in the collateral property.
The interest rates for hard money loans vary with different lenders and different regions. To illustrate, hard money lenders in California generally have lower rates than other parts of the country. This is because the extreme competition among hard money lenders there have driven the price lower. Regardless of region, all hard money lenders take on more risk, so their interest rates are higher than with traditional loans. Rates range from 10 – 15%, depending on the specific lender and the perceived risk.
The maximum loan amount is determined by the ratio of the loan amount to the value of a property, known as the LTV, or loan-to-value ratio. This means most hard money lenders will only lend up to 65-75% of the current property value. Some lenders will base their rates on the after repair value (ARV) of the property.
Hard money loans are designed for a specific purpose. If you find that you need one to catch a quick deal, then go right ahead. The higher interest rates may seem daunting in the beginning, but the positive benefits of acquiring funds (and the property!) quickly, and obtaining financing after all the banks have rejected you will outweigh the extra cost.