Private Money 101: A Basic Guide to Understanding Hard Money Loans

Hard money loans are often misunderstood, in part because of shady lenders who tainted this type of loan’s reputation by providing risky loans that left real estate investors dry with no property to show for it. Now it’s time to dispel the myths and talk about what hard money lending is really all about. This article will provide you with some basic information to get you started.

What Is a Hard Money Loan?

A hard money loan is a short-term loan secured by real estate and funded by private investors as opposed to conventional lenders such as credit unions or banks. The loan term can be as short as six months or as long as five years or more.

The required monthly payments consist of interest only, or interest and a certain amount of principal, then a balloon payment at the end. The amount loaned to the borrower is based on the value of the property for which the loan is being secured. This may be a property the investor already owns but wants to use as collateral or one the investor would like to purchase.

Hard money lenders place greater emphasis on the property value rather than the buyer’s credit, though credit is a consideration. Borrowers who are unable to obtain conventional financing due to short sale or foreclosure can be approved for a hard money loan if there is enough equity in the property.

When are Hard Money Loans Appropriate?

You can secure a hard money loan for almost any property type, including:

Some hard money lenders may only have experience in or prefer certain property types. Many lenders will not lend on residential properties that are owner-occupied because of additional rules and regulations, but some, including First Capital Trust Deeds, can.

Hard money loans can be used when the loan is needed within a short time period or when banks are simply not an option. If you have good credit, a stable income history, have the time for the lengthy approval process, and you haven’t been involved in a foreclosure or short sale, conventional borrowing may be a better option for you. Hard money loans are ideal for situations such as:

Why Use a Hard Money Loan?

One reason to use a hard money loan is quick funding. The timeframe is typically ten days or faster, compared to the month or 45 days it can take for approval of a conventional loan. The application process only takes a day or two, again, a much shorter time than that of a conventional loan.

Faster funding is a significant advantage for a real estate investor who wants to purchase a property with multiple competing bids. A hard money loan can provide a fast closure, setting the offer apart from others using conventional financing.

What Interest Rates and Loan-to-Values Can You Expect?

A hard money lender will charge different interest rates depending on the region. Rates will also vary from one lender to another.

There is more risk for a lender who takes on hard money loans. Because of this, interest rates will be higher for this type of loan than conventional options. Typically, they range from 7% to 12% percent, depending on the risk level. Points range from 2 to 4 percent of the total loan amount.

The loan-to-value (LTV) ratio will impact the interest and points. The amount the lender can lend is determined by dividing the loan amount by the property value. This is referred to as the loan to value, or LTV. The lower the LTV, the better terms you can expect.

Standard Borrower Requirements

Because hard money lenders are mostly concerned with the equity invested in the property, any borrower issues can be overlooked if the capital to pay the interest on the loan is present. The borrower is also required to demonstrate how the loan will be paid back. This may be a plan to renovate and sell the property and raise its value, find long-term renters for rental property investments, or to stabilize the property and obtain long-term financing.

Choose a Broker Instead of a Hard Money Lender

You should consider choosing an experienced mortgage broker instead of a direct lender. A broker will match each investor with private lenders who can offer better pricing for your investor specifications. Going directly to a hard money lender may lead to working with a lender that isn’t a perfect fit for you. Brokers understand the hard money lending market and will find financing options that work for you. A broker can offer multiple financing options because they have access to more financing resources from individuals, family offices, and pooled investment funds than a single direct lender, who can either choose to seal the deal or turn it down.

A broker can help you comparison shop to find the right hard money loan. Instead of speaking to each lender separately, you can discuss them with your broker all at once. In addition, some lenders choose to only work with brokers and can provide borrowers access to loans they would not have otherwise.