What is a Hard Money Loan?
Hard money loans fill the niche left out by conventional lenders.
A hard money loan is a type of loan issued by private investors or companies, rather than traditional banks or lending institutions. These loans are typically short-term and are secured by collateral, such as real estate. Hard money loans are exclusively for real estate investors and are used to quickly access the capital to purchase or renovate properties.
A hard money loan is a type of mortgage loan. Just like a regular mortgage loan, it’s secured against your property and you pay pre-determined interest rate until the loan is paid off. Just like with a conventional loan, your lender and you will work with a title company to wire the money to all the parties involved, to pay taxes and recordation fees dues. The title company will assist your lender with placing a lien against the property and will remove it once the loan is paid off. If you own a primary residence, you had gone through this process in the past. However, this is where the similarities between a tradtional and a privae loan end.
Hard money loans are typically used to buy and rehab properties that are in bad shape and require renovation – properties that conventional banks would not lend on. Another major difference between hard money loans and conventional loans is that hard money loans are based on the after-repair value of the property and not on the home’s purchase price or its current market value. This value is estimated by looking at newly renovated properties in the neighborhood that are of similar style and size. Because the after-repair value of the property is higher than the purchase price, hard money lenders can lend a significant portion of the purchase price and rehab budget. Without a hard money loan, the only option to buy a property that doesn’t qualify for conventional financing would be to pay cash. A hard money loan can help you leverage a modest nest egg to compete with all-cash buyers.
What are the advantages of a hard money loan?
There are several potential benefits of a hard money loan:
- Quick access to capital: Hard money loans can be processed and approved much more quickly than traditional bank loans, which can be helpful for real estate investors who need to act quickly to secure a property. At New Funding Resources, it typically takes 24 hours to get pre-approved for a hard money loan and 10-14 days to close.
- Flexible terms: Because hard money loans are typically issued by private firms like New Funding Resources, there is more flexibility in terms of the loan’s structure and repayment terms. This can allow borrowers to customize the loan to their specific needs. New Funding is a direct lender which means we develop our own underwriting guidelines based on our own unique risk tolerance.
- No credit requirements: Hard money loans are primarily based on the value of the collateral, rather than the borrower’s creditworthiness. However, many private lenders have minimum credit score requirements. At New Funding resources we use common sense: While we naturally prefer to work with borrowers who pay their bills, we don’t have an artificial credit score cut-off.
- Funding for non-traditional properties: Hard money lenders are specifically designed to finance non-traditional properties, such as fix-and-flip properties or long-term rentals, which do not qualify for traditional bank financing. In MLS, such properties always come with disclosures such as “investor special”, “sold as is,” or “cash-only.”
- Potential for higher returns: Real estate investors who use hard money loans to purchase and renovate properties may be able to earn higher returns on their investment than they would with traditional financing, due to the faster processing time and ability to purchase properties that may not have been available with traditional financing.
Hard money loans are more expensive because they assume more risk.
Hard money loans typically come with higher interest rates and fees than traditional loans. Why? Because they assume much higher risk than traditional banks and mortgage firms. After all, they’re based on the value that is not there at the time the loan is issued. An after-repair value is an estimate of the future value that might or might not come true. If a borrower wouldn’t rehab a property as promised, a lender might end up with a loan on a distressed property that far exceeds its value in its current conditions. Yes, technically, a lender can foreclose on the property, but may not be able to fully recoup the investment. Because of this risk, hard money lenders may charge higher interest rates and fees to offset the potential losses. In contrast, conventional lenders do not touch a scenario like this with a ten-foot pole, no matter the interest rate you are willing to pay.
Hard money loans should not be confused with subprime loans.
Hard money financing can only be used for investment properties. It should not be confused with subprime loans – loans designed specifically for high-risk borrowers: those with poor credit or no income. Though hard money loans might offer the same underwriting flexibility as some subprime loans (for example, we at New Funding Resources are not credit-score driven and don’t verify your income), they are specifically restricted to investors only. No owner-occupied properties can be financed by hard money.
For hard money loans to work, the after-repair value of the property must be high enough to cover the purchase price, the rehab budget, and all other costs associated with the transaction. Perhaps most importantly, it should leave room for sufficient profit for the borrower to compensate for his or her work and time.
Hard money loans are typically short-term.
To those with a limited amount of cash, hard money loans offer a unique and often the only opportunity to make money by fixing and flipping a property. Once the renovation is complete, there is no reason to stick with a hard money loan. An average borrower repays a hard money loan within a year by either selling the property or refinancing it with a conventional lender at a lower rate. At New Funding Resources, we don’t charge pre-payment penalties. That means that you can repay as quickly as possible minimizing your carrying costs and maximizing your profits.
Not all hard money loans are created equal.
It’s important to do your due diligence when selecting a hard money lender. Consider multiple lenders, compare their terms and fees, and ask questions to ensure you choose a lender who is a good fit for your investment needs.
You can access our detailed article on how to select the right private lender, but here are some factors to consider:
- Reputation: Look for lenders with a solid reputation in the industry.
- Experience: Consider lenders who have experience in the market and have successfully funded similar projects.
- Loan terms: Evaluate the terms and fees associated with the loan, including interest rates, points, and origination fees.
- Beware of over-promises: many private lenders may promise unrealistically low-interest rates and fees just to get you to apply with them. Unfortunately, such “favorable terms” often evaporate right before closing.
- Communication: Look for lenders who are responsive and easy to communicate with.
- Flexibility: Consider lenders who are flexible and willing to work with you to structure a loan that meets your needs.
- Transparency: Choose a lender who is transparent about the loan process.
Now you know what a hard money loan is – at least generally speaking. If you are a real estate investor doing business in Maryland, Washington, DC, Virginia, or Delaware, we would love to speak with you. We’ve helped thousands of investors make money in the local DMV market and will be delighted to have your business.
Still have questions about what a hard money loan is? Need advice on how to start flipping properties in the Washington, DC area? Looking to take your rehab business to the next level? Call New Funding Resources at 240-436-2340 today.