Understanding How Hard Money Financing Works
Fast funding in a competitive real estate market is one of the many reasons investors rely on hard money loans. If you are new to real estate investing or have never used a hard money loan, you likely have many questions.
How do hard money loans work? This type of lending is not the same as a conventional loan, traditional loan, or loans from private investors and credit unions.
Unlike a traditional lender or a conventional mortgage, most hard money loans offer flexibility to hard money borrowers looking for this type of short-term loan.
We have gathered this information to help guide you in learning about hard money loans so you can decide if they are right for you.
How do hard money lenders work? If this is a question you’ve been wondering, keep reading to discover more information.
What Are Hard Money Loans?
As a real estate investor seeking information on your funding options, you must learn as much as possible about a hard money loan and the way it works. A hard money loan is a non-traditional loan, meaning it isn’t considered a bank loan, conventional mortgage, or personal loan.
Hard money lenders are private lenders or companies that offer private money loan funding to real estate investors and developers. A private lender offers more flexible terms than banks and approves people based on the value of the property rather than the borrower’s creditworthiness, debt-to-income ratio, or personal financial situation.
How do hard money loans work? Like traditional mortgages and traditional financing, hard money loans are secured by the purchased property. Similar to conventional financing, if the borrower does not make their payments, the real estate investment property gets seized and sold by the lender.
Hard money loans are short-term loans. They are meant to be paid back in around twelve months, though the terms vary according to the lender.
The borrower’s goal should be to pay off the loan as quickly as possible because these loans typically have higher interest rates than traditional mortgage loans.
Hard Money Interest Rates
Most hard money lenders offer lending services with higher interest rates than traditional bank loans. Generally, you can expect to pay between 7% and 15% more in interest on the secured loan.
A lender may charge more in interest because this type of financing is a lot riskier. Another reason for the higher interest rate is the lack of vetting, especially regarding credit scores during the approval process.
Lenders don’t do a lot of background checks, and many don’t even check a borrower’s credit score, making hard money loan rates potentially higher than a traditional loan from a traditional lender. The lack of vetting makes a hard money loan much riskier for each lender.
What Are the Points on These Loans?
Loan points are the origination fee charged by the lender. These points also cover administrative costs, fees, and other expenses.
The points are typically based on percentages. One point equals 1% of the total loan amount. Hard money loans can vary greatly among lending companies, ranging from 2 to 10%. Most lenders will require you to pay these points as a part of the closing.
What About the Down Payment?
Just like traditional mortgages, most lenders of hard money will expect borrowers to put up some of their own money. With a hard money loan, you will put up your own cash in the form of a down payment.
While the amount varies among lenders, you can expect to pay around 10% of the real estate loan amount down. Before pursuing a hard money loan, make sure you have at least 10% of the property’s appraised value.
It is important to note that not all lenders require a down payment. In fact, a lender may offer 100% financing and cover closing costs, unlike traditional lenders. Because this is considered a risk for a lender, you can expect to pay higher fees.
EXAMPLE LOAN SCENARIOS
Do You Need a Hard Money Loan?
Now that you understand more about hard money loans, you need to determine if this loan is something you need. If you have tried the traditional route of seeking mortgage loans from traditional mortgage lenders and been turned down, this kind of loan may be best.
You will find hard money lenders typically don’t delve too deeply into your financial history like they would for a mortgage loan, but some will check your credit score. The lender wants to be sure you will repay the loan.
If you are finding it difficult to get approval because of poor credit, a hard money lender may be a perfect choice. If you need greater flexibility than traditional lenders offer, you may want to seek a hard money loan. Often, these loan agreements are much more flexible than traditional bank loans.
Traditional lenders rarely negotiate the terms. Hard money lenders are more flexible and will sometimes negotiate the payment schedule, monthly payments, loan terms, or other terms.
You must remember that the most important thing to the hard money lender is the collateral. Because the property acts as a guarantee on the loan, presenting a stellar deal to the lender will help you get approved.
Are These Loans Worth It?
You may be wondering if this loan is worth seeking. It’s important to realize this type of loan is not perfect, and no loan is.
However, if you talk with other real estate investors, you may find the lending services provided by these lending companies are what you’re looking for.
Hard money loans work by potentially putting you at risk if you are not positive you can rehab the property and sell it in time. You could end up dealing with cash flow issues or paying too much interest.
As you begin researching your options and learning how a hard money loan works, there are things to consider. If you’ve already started the approval process and have questions, reach out to your real estate agent or loan officer.
What Can Individual Investors Expect From This Loan Type?
Approval for this type of loan is typically easy and fast. It is important to note that the way the lender determines the LTV (loan-to-value) ratio will likely mean, in some cases, that individual investors will need assets to qualify.
The lender will keep conservative ratios because they know this means they can sell the property and get a nice profit if you default or if the real estate industry slows down. LTV ratios typically hover between 65% and 75%.
If you are a house flipper, this type of loan will make the most sense for your investment needs. You purchase a property to rehab and sell it as quickly as possible. By paying off the loan as quickly as you can, you can avoid high-interest costs, which means more money in your pocket.
Reasons Investors Seek This Loan
Multiple reasons cause investors to seek a hard money loan, including the following:
House Flipping
One of the most common reasons people seek one of these loans is for house flipping. Because house flippers work quickly to snatch up deals, rehab them, and sell them, they need fast financing.
Hard money loans allow house flippers to grab the best property deals before someone else snatches up the property. No true investor has time to wait around for approval. Waiting on bank approval often leads to missed opportunities.
Investment Properties
Many people want to invest in rental properties, but they may not qualify for traditional bank loans. Perhaps you don’t have the best credit score, or your payment history is shaky. It is easier to qualify for a fast money loan with these issues.
Commercial Properties
Business owners also use hard money loans to purchase commercial real estate. Business owners will typically seek this type of loan when they cannot secure traditional financing through a bank.
Sometimes, a unique property may not qualify for traditional funding. Loan limits on traditional loans can also impede a business investor. There are fewer limits on hard money options.
Understanding the Pros and Cons
We believe you have the right to understand the pros and cons of hard money loans to make an informed choice. The following offers information on both the pros and cons of these loans.
Pros:
- These loans offer a much faster approval timeline. You can get your money in ten days or less in some cases.
- Your approval is based on the property purchased and not credit scores or income.
- The terms of these loans are much more flexible. You can often negotiate with the lender to get the terms you need, especially if you have a good relationship with the lender.
- Hard money lenders have much fewer requirements than banks.
- Most lending companies don’t have a pre-payment penalty, but it’s important to ask.
- Unique, off-market properties can qualify for this loan type.
Cons:
- The interest rates can be significantly higher.
- Down payments are sometimes required.
- If you default on the loan, the lender will take the property and sell it.
- Points must be paid upfront.
MORE EXAMPLE LOAN SCENARIOS
How to Get a Loan From Hard Money Lenders
First, you need to find the right lender to take care of your loan needs. Check customer reviews and ask fellow investors for information. Making an informed choice helps ensure you have a positive experience.
A reliable lender will usually offer online applications that allow you to get a quick pre-approval. The process is fairly straightforward, and borrowers can often receive funding in around ten days or less.
Helpful Tips for Seeking Hard Money Loans From a Hard Money Lender
How does a hard money loan work? If you’ve never pursued this type of loan, the process can be somewhat intimidating because you don’t know what to expect.
We have put together some tips that should help prepare you for this loan.
- Be wary of lenders who require heavy upfront fees. Check the terms before agreeing to sign with any lender.
- It is wise to deal directly with a lender whenever possible. Find out if the lender is a true lender or a broker who will pass your loan on to another lender.
- Make sure you find a lender with plenty of experience working with hard money loans. This is not something you can leave to novices.
- Be sure to prepare your loan exit plan before seeking a loan. Lenders may be interested to see your plan for repaying the loan in a timely manner.
- Make sure you do not underestimate your loan needs. Carefully review the costs.
Get Started Right Away for Pre-Approval
The lenders we partner with understand you do not have time to wait around for funding. We are here to answer your questions and guide you through the entire process. Start the easy process today to get the fast approval you need for your next property deal.