What is a hard money loan?

What is a hard money loan?

A hard money loan is a loan secured by real property. Hard money loans are considered “last resort” loans or short-term bridging loans. These loans are mainly used for real estate transactions, and the lenders are generally individuals or companies, not banks.

key takeaways

  • Hard money loans are mostly used for real estate transactions and are money from individuals or companies rather than banks.
  • Hard money loans are usually short-term and a quick way to raise capital, but they are more expensive and have a lower loan value.
  • Because hard money loans are reliant on collateral, not the applicant’s financial situation, the financing term is shorter.
  • The terms of a hard money loan can usually be negotiated between the lender and the borrower. These loans are usually secured by the property. 
  • Borrower defaults can still lead to lucrative deals for lenders by collecting collateral.

How hard money loans work

The terms of hard money loans are primarily based on the value of the property used as collateral, not the creditworthiness of the borrower. Since traditional lenders such as banks do not offer hard money loans, hard money lenders are often private individuals or corporations that see value in such potentially risky ventures.

Hard money loans may be sought by real estate developers who plan to renovate and resell real estate that is typically used as collateral for financing within a year, if not earlier. The higher cost of hard money loans is offset by the fact that borrowers intend to pay off the loan relatively quickly. Most hard money loans have terms of one to three years and some of the other advantages they offer.

A hard money loan can be seen as an investment. Many people are actively practicing this as a business model.

Special Considerations for Hard Currency Loans

The cost of providing hard money loans to borrowers is generally higher than financing provided through banks or private lending programs, reflecting the higher risk that lenders take by providing financing. However, the increased fees are a trade-off for faster access to funds, a less stringent approval process, and potential flexibility in repayment schedules.

Hard money loans are available for working-around situations, short-term financing, and borrowers with poor credit profiles but substantial assets. Because it can be issued quickly, hard money loans can be used as a way to avoid foreclosure.

The pros and cons of hard money loans

Hard currency loans have pros and cons related to the approval process, loan-to-value ratio (LTV), and interest rates.

favorable opinion

One advantage of hard money loans is the approval process, which is often much faster than applying for a mortgage or other traditional loan through a bank. Private investors backing hard money loans can make decisions faster because lenders focus on the collateral, not the financial situation of the applicant.

For example, lenders spend less time combing through loan applications, verifying income, and reviewing financial documents. This process will be smoother if the borrower already has a relationship with the lender.

Hard loan investors don’t care about getting repayments because if the borrower defaults, the value and opportunity to resell the property themselves may be greater.

Cheat

Because the real estate itself is used as the only protection against default, hard money loans typically have lower loan-to-value ratios than conventional loans: around 50% to 70%, compared to 80% for regular mortgages (though, if the borrower is experienced borrowers and may have a higher loan-to-value ratio).

Also, interest rates tend to be high. For hard money loans, interest rates may even be higher than subprime mortgages. As of 2020, the average interest rate on hard money loans in the US is 11.25%, with rates ranging from 7.5% to 15% in 2020.

Another disadvantage is that hard loan lenders may choose not to finance owner-occupied homes because of regulatory oversight and compliance rules.

By aamritri

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