What is a Hard Money Loan and When is it Used?

What is a Hard Money Loan and When is it Used?

If you’re looking for real estate financing, an option you may want to keep in mind is a hard money loan. This type of loan uses a specific piece of property as collateral, but it functions much differently than a mortgage. Here’s all you need to know about hard money loans to decide if one is right for your situation.

How a Hard Money Loan Works

When you apply for a hard money loan, you’re applying to one or more investors that fund loans to earn a return in the form of the interest. Already, there’s a key difference here between a hard money loan and a more traditional loan option (think your typical mortgage) – this loan is investor-funded whereas traditional loans are usually backed by a bank or other financial institution.

There must be property attached to the hard money loan as its collateral, and this can be either property you plan to buy with the loan or property that you already own. If you were to default on your loan, the lender could then repossess that property.

That property plays a pivotal role in approval for the loan, and lenders generally loan up to a certain percentage of the property’s value at the time of the loan application. This varies from lender to lender, but about 65 to 75 percent is normal, meaning you may get a hard money loan for $130,000 to $150,000 if you’re looking to buy a $200,000 home.

Once you get your loan, the term won’t be that long, with a typical term being a year. Expect a higher annual percentage rate (APR) than you’d get through a mortgage. However, monthly payment amounts won’t be that high because this type of loan includes a balloon payment at the very end, which is when you pay off most of it. If you need to extend your loan at the end, you can often do that, although it’s best to avoid this whenever possible due to the interest you’ll pay.

Advantages of a Hard Money Loan

A hard money loan has some obvious drawbacks. You’ll spend more on interest and have much less time to pay it off than you would with a mortgage, and that balloon payment can be tough to pay back. There are also a few key advantages with hard money loans, though, including:

  • Funding timeframe – Hard money lenders can get loans funded in a matter of weeks or less, allowing you to close deals with less waiting around.
  • Easier approval – Since property value is the main factor to getting approved on a hard money loan, credit score issues aren’t as much of a problem as they normally would be.
  • Available with a wide variety of properties – Your typical mortgage lender would be wary about loaning you money for a property you plan to fix up. Hard money lenders are far more willing to work with you in this situation.

When Does a Hard Money Loan Make Sense?

A hard money loan is a good idea if you need a loan, but the more traditional options are out because you don’t have a sufficient credit score. If your house is in danger of foreclosure, you could find that a hard money loan is just what you need.

A very common situation when you’d typically use a private money loan is flipping properties. These kinds of deals can happen quickly, and you can receive your funds much faster with a hard money lender than with a mortgage lender. And a mortgage lender may not even approve you for a fix and flip, while a hard money lender would be more used to that.

Remember that just because hard money loans are often used for flips doesn’t make it a piece of cake to get one for your flipping project. The lender will still consider their risk, and they’ll want to feel confident that you can repay what you borrow.

They will look at your debt-to-income ratio to see if you have enough money to make your loan payments. And they’re going to evaluate how likely it is that you flip the property and make enough on that deal to pay off your loan in full. Experience flipping properties and a thorough presentation can both help you convince them of that.

Depending on why you need the money, a hard money loan could end up being the best fit. If the most important factors for you are the funding timeframe or the ease of approval, then it’s worthwhile to look into your hard money lender options. And if you’re getting into flipping, then it’s good to build a relationship with a hard money lender sooner rather than later.