Over the past decades, most investors have tried real estate investments to build their wealth. Anyone can succeed if they have a solid understanding of how the real estate market works.
The house flipping business garners a total sale value of more than $600 billion in the US every year. Still, as a real estate buyer, one of the biggest hurdles most investors face while closing the deal is the lack of sufficient funds. Even though the latest economic environment remains stable, not all real estate investors have a huge amount of capital to close the deal in no time.
So how do you immerse yourself in the real estate market without sufficient cash in hand? This is when hard money lenders come into the picture. Many real estate investors approach these lenders to get hard money loans, as these investments have a better potential to generate profit. But, What is a hard money loan, how does hard money lending work, and is it a good idea to get the help of a hard money lender for your real estate project? Keep scrolling to find out more.
Hard Money Definition
Hard money is an exclusive term used mostly in the United States and Canada, where hard money mortgage loans are quite common. Hard money is the last option for property buyers looking for capital when it comes to commercial real estate investments.
But, what is hard money? In terms of financial context, it refers to specialized financing based on assets. Here the borrower receives funds by keeping the real estate property as security. In most cases, private money lenders for real estate are the biggest lenders of hard money residential loans that are often not easy to acquire.
Hard Money Loan: Explained
Hard money loans, also known as private money loans or bridge loans, are short-term financing provided by private money lenders or a hard money lending company that accepts assets or real estate property as collateral. Also, it’s a financial tool that veteran and professional real estate investors often use to meet their mortgage needs.
Borrowers often turn to private money mortgage loans once traditional lenders deny their loan applications. While a traditional mortgage may take more than a month to close the deal and purchase the property, you can close the deal with a hard cash loan in a few days.
Working With Hard Money Lenders
Hard money lenders are private companies or investors that use their funds to finance the real estate projects of the borrower, keeping the property as collateral. Investors will not be able to find this type of hard money lending process at the local banks.
Since hard money lenders do not have the same regulations as the traditional money lenders, they are free to create their own rules concerning debt-to-income ratios or credit scores their borrowers must possess. For hard money lenders, the value of the property being purchased is more important than the borrower’s creditworthiness.
How Do Hard Money Loans Work?
Before we figure out how to get a hard money loan, let’s find out how hard money loans work?
A hard money loan is a perfect option for borrowers who cannot or prefer not to get financing from a traditional money lender. Though hard money loan terms are quite similar to the conventional loans, you will come across some differences like:
- Private money lenders for residential real estate often charge higher interest rates for the loan provided.
- Hard money lenders often tend to finance loans that conventional lenders reject.
- Hard money lenders make quick and clear decisions on whether or not to finance a loan for a specific real estate project.
Hard money lenders provide borrowers with capital based on the value of the real estate property being purchased. For this, the lender conducts a quick check on the buyer’s finances to figure out their credit score. So, the hard money lending process is less rigid than the traditional loan process. This enables the financing process to be quicker, enabling the borrower to close the deal within a few days.
In general, private money mortgages have a short repayment term of only a few years. This is much shorter compared to the 20- or 30- year term period of the traditional mortgages.
How To Get A Hard Money Loan?
Though real estate is the safest way to build wealth, investors must be aware of the right type of funding. If you’re planning to purchase real estate property to flip, you will come across various funding options. Traditional lenders like banks are not always the best option, as they tend to reject your application and are quite stringent when it comes to house flipping investments.
One of the best alternatives that are becoming popular with investors these days is working with hard money lenders. These private money lenders for residential real estate provide funds that are sourced from hedge funds, individual investors, or even raised from the public. Though private funding for real estate using hard money loans is a perfect choice for investors, finding the best hard money lenders can be a huge challenge.
For this, it is essential to consider the hard money lender’s interest rates and reputation. You can get advice from fellow house flippers or a trusted real estate agent to choose the right lender. Once you have chosen the perfect hard money lender for your investments, be prepared for the following procedures:
- Prepare a huge amount as a down payment.
- Hire an attorney to go through the loan terms once it has been approved.
- Get all the necessary paperwork to provide as proof of income and financial stability.
- Prepare an effective backup strategy to pay off the mortgage loan.
Once the private money lender has been selected, they will evaluate the risks by underwriting the loan. For this, the lenders will evaluate your ability to repay the loan and credit report and ask for an appraisal on the property. Only once the entire evaluation process is complete will they approve the loan.
If the loan gets approved, you must wait for the closing date to sign the deeds of trust and promissory notes documents. This is to secure the lender’s investment by placing your property as collateral. If you fail to repay the loan, the lender has the absolute right to claim your property to recoup the investment.
Hard Money Loan Requirements
As mentioned earlier, Hard money lenders have lesser requirements than traditional lenders. As part of the hard money loan requirements, lenders request 30 to 40% as equity or down payment for commercial properties and 25 to 30% for residential properties. You can also try using multiple real estate properties to get a hard money loan. The lender will require you to provide documents stating your financial stability to make monthly loan payments to get the loan approval.
What Hard Money Loan Rates Can You Expect?
In general, hard money loans are more expensive than the traditional loan types. As per the statistics provided by Freddie Mac, the average conventional loan rate for a 30-year fixed-rate loan was only 3.01% in September 2021. On the contrary, hard money loan rates were as high as 8 to 15%. Hard money loan rates are expensive due to the preferred loan-to-value ratio provided by the money lenders.
When To Use Hard Money Loans?
Hard money loans may not be the best option for all types of deals. When purchasing a primary residence, if the borrower has a good income history and credit score, they can easily opt for the conventional financing methods. Hard money loans are a source of capital when traditional funding fails, or you need to get a loan within a short timeframe.
Often, hard money lenders provide financing to borrowers in cases where traditional lenders have no interest in financing these projects. A good hard money loan example of this is the fix and flip loan option. Here, the investors purchase the property for a short-term loan and sell it off at a higher price to gain profit. In most cases, the short-term loan is taken for 12 months. Such short-term financing often does not work with a banking institution’s business model. Banks prefer to lend money to investors for a long time period to make a small interest rate over a long period of time.
Some of the other ideal situations to opt for hard money loans are:
- Fix and Flips.
- Wholesale funding.
- Construction loans.
- When the borrower has credit issues and requires hard money loans for bad credit.
Final Thoughts: Should You Get a Hard Money Loan?
Whether to get a hard money loan or not depends on your financial situation while closing a deal for your real estate project. As with any loan, make sure to have a contingency plan to pay off the mortgage loans even before you borrow. Nobody wishes to lose the loan’s asset collateral because they made defaults in the monthly payments. Along with losing the real estate property set as collateral, not being able to repay the hard money loan can cause major harm to your credit score.
That’s why beginners and less experienced investors must educate themselves on hard money loans before they approach the best hard money lenders for beginners to make the right decision on their investment projects.
