Hard money loans are a mortgage alternative for borrowers who need fast investment capital, who only wish to hold onto a new property for a short period of time, or who cannot obtain a more conventional real estate loan. They are issued by private investors or corporations instead of by a bank, which allows greater flexibility in setting terms and assessing risk.
“Hard money loan” is a term unique to the U.S. and Canada where this type of loan first developed in the 1950’s. At first, the industry was exclusively a last-resort option for borrowers, but today, it is much more diverse. Below, we will look at 10 key facts about hard money loans in order to gain a better understanding of what they are and when they might be a suitable option.
Simpler loan applications
Since complex bank regulations are not involved, hard money loan applications are simpler and can often be approved in only 24 hours. A ten-day closing period is normal for these loans, but in some cases, they close in only a few days.
A word about bridge loans
Sometimes, hard money loans are equated with “bridge loans,” but in other contexts the terms are distinguished. When kept distinct, “bridge loan” typically refers to commercial or investment-property loans used temporarily while a piece of real estate is in transition. “Hard money loan” is used more often when the loan is taken out to deal with delinquent mortgages, foreclosures, and bankruptcies. However, these definitions are not hard and fast nor universally adhered to.
This type of loan is not backed primarily by borrower credit rating, assets, or equity. While all of the above can be part of the equation, the main collateral is the property being purchased itself. This makes hard money loans riskier to lenders, and therefore, a lower loan-to-value (LTV) ratio is used, often ranging from 60-75% of the total property value.
LTV for hard money
The “value” in the LTV of hard money loans is not the same as the market value used by banks. Instead, it is somewhat lower, being based on what the lender could expect to get for the property in a one to four month selling time.
The interest charge on hard money loans is higher since lenders are taking greater risks and the terms are short–normally 12 months or less. Higher rates than even subprime loans are typical, ranging from 12-21%. If a default occurs, the rate generally increases to around 25% to 29%. Additionally, there may sometimes be a prepayment penalty.
Besides the basic interest rate, there will also be “point rates.” A “point” is 1% of the total principle, and hard money loans usually add 3-6 points to the loan as compared to the 1-3 points of conventional mortgages.
Typically, hard money lenders require first-lien position. This means that, if the borrower defaults on the loan, they will be “first in line” for repayment from foreclosure sales. More rarely, such a lender will take second-lien position, in which case, it is called a “mezzanine loan.”
Purchase and repair
One of the most common uses of hard money loans is to quickly gain capital to both purchase and repair a piece of property. Some investors wish for a short-term loan arrangement because they “flip” properties every few months, and they plan to pay off the loan as soon as possible. Lenders will evaluate both the present value of the property and its after-repair value before issuing the loan.
Lenders will frequently need all of the following information on a hard money loan application: property location, recent appraisal and inspection data, the purchasing price, the planned resale price, and the estimated remodeling expenses. The borrower’s credit rating, current income, total assets, and level of experience in the real estate market will also be relevant.
In case of default…
Should a borrower default on the loan, the lender has the option to foreclose. However, most lenders seek to avoid this scenario and will work with borrowers who are struggling to make the payments.
While some lenders take advantage of desperate borrowers, others lenders, like Capital Concepts, offer highly reasonable terms for this type of loan. For example, Capital Concepts has hard money to permanent loan programs with as little as 7% interest plus 2 points across a 60-day period. They also have regular hard money loans with interest as low as 14% plus 3 points.
Hard money loans are helpful in many situations despite their higher fees and rates, and they are deemed worthy investments by many lenders despite the higher risk. In general, they are only for short-term financing projects and for preventing a looming foreclosure. There are also situation in which a hard money loan allows a buyer to quickly access the capital to purchase a home before the opportunity to make a heavily discounted acquisition passes him by. In such cases, a hard money loan actually helps him to increase his own profits.
While hard money loans are not best for every situation, when used effectively, they can be beneficial to both borrower and lender alike.