A hard money loan is a loan that is primarily used for real estate transactions. A hard money loan differs from a traditional mortgage in that the loan terms are short – and the loan is backed entirely by the collateral rather than the applicant’s financial position. Confused? Let’s do a deep dive to learn “What is a hard money loan?” so you can share this information with your real estate clients.
Understanding Hard Money Loans
Most of your real estate clients will take out a mortgage to purchase a home. The mortgage approval process takes time, as the lender must verify your client’s income and assets. When working with a bank or mortgage company, it may take a month or two for the loan to come through for your buyer.
But sometimes, a client will want to purchase an investment property quickly. They may turn to an individual or a company for a quick, hard money loan. Hard money lenders charge a higher interest rate in return for quick access to the money. Hard money lenders typically use the property the individual is purchasing as collateral. So, if the borrower defaults on the loan, the lender can resell the property themselves.
Characteristics of Hard Money Loans
Hard money loans are typically used by someone buying real estate who needs quick access to money. Besides being quick loans, here are other characteristics of hard money loans.
1. Hard money loans are secured by a property.
A hard money lender will assess the property’s value and determine the loan amount based on a percentage of that value. The loan is backed by this asset. If the buyer defaults on the loan, the property will go to the lending institution.
2. Hard money loans are short-term loans.
Hard money loans often have terms ranging from a few months to a few years. They are not intended for long-term financing, like a traditional 15 or 30-year mortgage.
3. Hard money loans have higher interest rates.
Hard money lenders charge higher interest rates compared to traditional lenders. These loans are considered riskier by lending institutions because the money is often used for investment properties that may need significant renovation. Thus, borrowers are charged higher interest rates for hard money loans.
4. Those with less-than-perfect credit may qualify for a hard money loan.
Hard money lenders may have more flexibility in their lending criteria. They may be more willing to work with borrowers with a less-than-perfect credit history if the value of the property they are purchasing is sufficient.
5. Hard money loans may require a significant down payment.
The hard money loan amount is usually based on a percentage of the property’s appraised value, known as the loan-to-value ratio. Hard money lenders may provide loans with a loan-to-value ratio of 50%-70%, which means your client may need a significant down payment.
What Is the Purpose of a Hard Money Loan?
Hard money loans are typically used by real estate investors.
For example, you may have a client who wants to purchase a property to flip – or renovate and resell within a year, if not sooner. They may take out a hard money loan to buy the property quickly.
Or you may be the REALTOR® for a distressed property that may not meet the criteria for traditional financing. You may find a buyer with a hard money loan to purchase the property.
A person may also take out a hard money loan if they have credit challenges. Hard money lenders are more interested in the property’s value than the borrower’s credit history. However, the buyer may have to have more than a 20% down payment for the property.
Finally, sometimes buyers will turn to hard money loans to buy non-traditional properties, commercial real estate, or properties that are “unique opportunities” requiring immediate action. Borrowers may have to agree to higher interest rates for these high-risk loans.
Pros and Cons of Hard Money Loans
Hard money loans are considered riskier than traditional financing. However, they may work well in some situations.
Pros of hard money loans for the borrower
- Faster approval process than traditional loans
- Loan approval based on the property’s value, not credit history
- Lenders may offer flexible loan terms
Cons of hard money loans for the borrower
- High-interest rates
- Typically require large down payments
- Lenders charge higher upfront fees and closing costs than traditional lender
- Less time to repay
- Can carry a prepayment penalty
Working with real estate investors can be a lucrative niche. Once you have established a relationship with investors in your community, you can focus your energies on finding perfect properties that meet their criteria.
But before you can become a REALTOR® focused on investment properties, you need to earn your real estate license in your state.
Turn to Colibri Real Estate for your pre-licensing education and continuing education focusing on investment real estate. Soon, you may be the go-to real estate agent for investors in your community.
Source:
Segal, Troy. “Hard Money Loan Definition.” Investopedia. Accessed December 5, 2023. https://www.investopedia.com/terms/h/hard_money_loan.asp#:~:text=A%20hard%20money%20loan%20is%20a%20type%20of,generally%20being%20individuals%20or%20companies%20and%20not%20banks.
