Hard money loans, also called bridge loans, are secured non-conforming loans that usually require collateral in the form of real estate. Consumers commonly use hard money loans to invest in real estate property, purchase commercial properties, or fund the repairs and renovations for flipping a house. Borrowers with poor credit who are unable to receive approval for a Personal loan or who are looking for higher loan amounts than traditional lenders are willing to offer may be able to utilize hard money loans.
Here, you will learn how hard money loans work, as well as the pros and cons of hard money lending.
Hard Money Lender vs. Traditional Lender
So what’s the big difference between hard money loans and traditional loans? To start, a traditional lender will review an applicant’s credit report and credit history and may base approval on the credit score of the applicant. Comparatively, a hard money lender determines approval typically on the equity of the collateral instead of on the borrower’s credit history. Other differences between hard money lenders and traditional lenders include the following:
- Interest Rates – Hard money loans usually have incredibly high-interest rates, while consumers may be able to receive more competitive rates with traditional loans.
- Repayment Terms – Hard money lenders may require borrowers to pay back their loan within a few years or less, while traditional lenders may be able to offer more flexible terms based on the budget and financial situation of the borrower.
Why Do People Seek Out Hard Money Lenders?
People may seek out hard money loans and hard money lenders for a few different reasons. The most common reasons are:
- Real Estate Investing – Real estate investors who are either unable to receive approval for a traditional loan or who are looking for higher loan amounts than traditional lenders are willing to offer may seek out a hard money loan. Borrowers who seek out hard money loans for real estate investments should be aware of the risk they are taking. There is no guarantee that the investment property will be successful, and there is also a chance there may be a dip in the market, causing the value of the real estate to drop drastically.
- Purchasing Commercial Property for a Business – Business owners may also seek out hard money loans to pay for a commercial property for their business. New business owners may seek out a hard money loan in order to establish a brick-and-mortar location for their business or even to expand their existing business and open up an additional brick-and-mortar location.
- Flipping a House – Lastly, another common purpose of hard money loans is to front money for the renovations and repairs required to flip a house successfully. Flipping a house essentially involves someone purchasing a home that needs work, fixing it up, and then selling it for a profit. If done successfully, people can actually earn enough profits to make a living out of flipping houses.
Benefits of Hard Money Loans
Hard money loans can come with many benefits that are appealing to borrowers looking to flip a house and to private investors who want to invest in real estate or commercial properties. Check out some of those benefits below.
Due to the high loan amounts and collateral involved, many secured loans can take a few weeks or more before the borrower can sign their contract and receive their money. Hard money loans are vastly different, with borrowers being able to receive their approved funds in just a few days!
This can be very convenient for investors looking to lock down an opportunity quickly. However, make sure you still create a financial plan so you don’t enter into your high-risk debt unprepared.
Approval Generally Based on the Value of the Property
Many loans base approval, loan amounts, interest rates, and other loan factors on the borrower’s credit score. While this may not be a problem for borrowers with good credit who may qualify for higher loan amounts and lower rates, it can be a major roadblock for borrowers with a less-than-stellar credit history. Hard money loans are different in that lenders heavily base approval and loan details on the equity in the borrower’s collateral instead of their credit score. This is why consumers who couldn’t get a house loan with bad credit may turn to hard money lenders.
Less Strict Underwriting
Since hard money loans are so streamlined, they often have a much less vigorous underwriting process than other loans. While less strict underwriting can help the approval and funding processes move along faster, it may also mean that the details of your loan are much less personalized.
Potential to Profit by Flipping Investment Properties
As discussed, hard money loans are often used to flip houses. If done correctly, borrowers can profit significantly by flipping a home. Depending on the area the home is located and the types of repairs and renovations done to the home, house flippers may be able to profit tens of thousands of dollars or more! If profits are high enough, borrowers may even be able to completely pay off their hard money loan and keep some extra money for themselves as well.
Potential Risks of Hard Money Loans
While there are great hard money loan pros, including high funding amounts, fast approval, and more, borrowers should also be aware of the heavy risks that may also accompany a hard money loan. Below are some hard money loan cons you should consider before applying for this type of funding.
High Hard Money Loan Rates
Hard money lenders tend to charge exceptionally higher interest rates, especially when compared to other more traditional forms of funding. Interest rates are one of the most impactful factors of a loan and may cause the total cost of a loan to increase significantly.
Hard Money Lender May Require a Large Down Payment
It’s not uncommon for hard money lenders to require a down payment of 20% of the total loan amount. So, say you applied for a hard money loan for $100,000. With a loan like this, the hard money lender may require you to pay a $20,000 down payment before you may receive your funding. If you are unable to afford the down payment, you may not be able to obtain approval for a hard money loan.
Shorter Loan Terms
Terms for hard money loans are also usually on the shorter side, typically a few years or less. With funding amounts for hard money loans being so high, paying off the entire balance within a short period of time may be difficult. Just like any other loan, missing a payment on your hard money loan repayment may negatively impact your credit score for up to seven years.
As with all secured loans, borrowers risk losing their collateral if they miss a certain amount of payments or default on their loan agreement. Since hard money loans are typically secured with real estate property, losing collateral could result in a major financial loss for the borrower. Furthermore, with a default on record, it may be more difficult for borrowers with failed hard money loans on their file to get approved for other types of funding in the future.
May Need a Successful Track Record for Approval
As hard money loans are a high risk for borrowers, they are also a high risk for lenders as well. This risk is part of the reason many hard money lenders charge such high-interest rates. Hard money lenders may also seek to financially protect themselves by requiring borrowers to have a proven track record of successful hard money loans in order to receive approval. While this requirement may not be an issue for experienced house flippers, it may prove extremely challenging for someone seeking out hard money loans for the first time.
What Is the Difference Between a Hard Money Loan and a Mortgage?
Two common ways people pay for real estate are through hard money loans and traditional mortgages. While hard money loans may be better suited for house flippers or investors, a traditional mortgage is designed for consumers looking to pay for their own homes or place of residence.
Hard money loans are usually non-conforming, meaning they do not abide by the same rules and standards as many other traditional lenders. Traditional mortgages, on the other hand, can be insured by the Federal Housing Administration. The Federal Housing Administration (FHA) was established in 1934 and currently insures family homes, multifamily properties, residential care facilities, and hospitals. During their time, the FHA has insured approximately 50 million mortgages throughout the nation.
An FHA-insured mortgage means that the loan agreement is protected from potential losses. If a consumer defaults on their mortgage that is insured by the Federal Housing Administration, the FHA will pay a claim to the mortgage lender for the unpaid principal balance. Due to this protection, many mortgage lenders may be more willing to approve borrowers for mortgages when they would not have without the additional insurance protection.
Approval Time and Repayment Terms: Hard Money Loan vs. Traditional Mortgage
Hard money loans and mortgages also have other differences, mainly regarding approval time and repayment terms. As mentioned, hard money loans often have very brief repayment terms and a fairly quick approval process. Comparatively, mortgages can offer consumers more time to pay but usually come with a more extensive approval process that can take time. Borrowers may be able to receive a hard money loan in a few days or less, and mortgages can take weeks or even months to complete. While this may seem like a long time, keep in mind that mortgages may also have a more complex underwriting process, which also means consumers may get more personalized terms and rates.
Furthermore, mortgages typically also come with much more convenient repayment terms. Hard money loans are typically due within a few years, but borrowers can get decades to pay off their mortgages. A common mortgage loan term is approximately 15 to 30 years or more.
Hard Money Loan vs. Home Equity Loan or Line of Credit
Borrowers may also seek out a home equity loan or home equity line of credit in lieu of a hard money loan. Home equity loans and lines of credit are most often used to refinance a traditional mortgage. While consumers cannot be guaranteed to receive a home equity loan with bad credit, there are still options available for borrowers with a less-than-perfect credit history. If you are having trouble paying off your traditional mortgage and need assistance, refinancing with a home equity loan or line of credit is most likely a much more sustainable option over hard money loans.
Should I Get a Hard Money Loan or a Personal Loan?
At the end of the day, there are many financing options available for borrowers looking for money. Borrowers with plenty of expendable income looking to invest or flip a house may do well working with hard money lenders, while borrowers who are budgeting with low income or going through a financial emergency may benefit more from traditional financing. When thinking about what type of lender you want to work with and what type of financial product you want to receive, ask yourself a few questions. What are you looking to pay for with your loan? How fast do you want to pay off your balance? Do you have the available funds for a down payment? What kind of interest rates and monthly payments can you afford? By answering these questions, you may be able to narrow down your search and decide if a traditional loan or hard money loan would work best for you.