Hard Money Explained
One of the biggest challenges real estate investors often face is coming up with the capital they need to fund a deal. Without a ready supply of cash on hand, financing may be the most obvious solution but you could run into roadblocks when attempting to get a loan through a traditional bank. Hard money lending, on the other hand, may offer a smoother path to borrowing.
What is hard money?
Hard money refers to a specific type of loan that’s tied to an asset, frequently real estate. Hard money loans aren’t granted by banks. Instead, they’re issued by private individuals or groups of individuals and these hard money lenders typically focus their efforts on lending within a specific geographic region. RealtyShares, for example, is a California hard money lender operating in a range of local markets, including San Francisco, Los Angeles and the Lake Tahoe area.
Hard money loans vs. bank financing
Unlike a bank, which uses funds from its depositors to make loans, hard money lenders rely exclusively on private funds. Another key difference is that hard money lenders tend to focus more on the characteristics of the property you’re trying to invest in, rather than your personal credit history or financial background, when making approval decisions.
If you’re planning to purchase a home to rehab and flip, for example, a hard money lender’s likely to be more concerned with the property’s after-repair value than your credit. The lender wants to have some assurance that your investment is going to yield enough profit to repay what you’ve borrowed. That doesn’t mean, however, that your credit won’t undergo some scrutiny. If there’s a foreclosure or bankruptcy on your credit history, for example, you may have a harder time qualifying for a loan.
In terms of structure, hard money loans are by design a tool for financing over the short term. Whereas a bank may give you a 30-year mortgage, a hard money lender typically expects repayment in full within 12 months or less. Some hard money lenders may extend loan terms as long as five years but that’s the exception, rather than the rule.
The amount you can borrow can vary from one hard money lender to another but the maximum loan-to-value ratio (LTV) usually falls between 50% and 75%. That means that you’ll need to either bring some of your own cash to the table or secure secondary financing to make up the difference. With a bank, the preferred LTV is in a similar range of 70%-80%.
One important thing to keep in mind is that hard money loans tend to carry higher interest rates than more conventional financing options. Depending on the lender, your rate may range anywhere from 10% to 20%, which is well above what banks typically charge. A hard money lender may also tack on points or charge a higher origination fee than a bank would.
The trade-off is the convenience factor. A bank’s going to put more scrutiny on your financials, including your credit score, when you apply for a loan. Assuming you’re approved, it may take a month or longer for your loan to close. In the meantime, another investor could come along and scoop up the property you’ve got your eye on. With a hard money lender, the merits of the property itself carry more weight than your credit and it’s possible to get funding within a week. That kind of speed is invaluable in a competitive market.
Hard money loans: Who uses them?
Generally, real estate investors can get a hard money loan for almost any property type, including single- and multi-family residential properties, commercial properties, industrial properties and land investments. Some hard money lenders cover the gamut in terms of the types of property they finance; others specialize in one or two property types. One thing to keep in mind is that many hard money lenders don’t extend loans to investors who are purchasing owner-occupied residential properties, which are subject to greater federal regulation.
In terms of when a hard money loan might make sense, there are a few scenarios where this type of financing may be more suitable than a traditional bank loan. For example, if you’re interested in purchasing a rehab property that you believe you can flip relatively quickly, hard money could work better in the short term. The same is true if you’re looking for a land or construction loan and time is of the essence. In any of those scenarios, you have to weigh the cost against the convenience.
Choosing a hard money lender
If you’re considering a hard money loan for your next investment property, it pays to carefully research your lender options. Compare the rates and loan terms various hard money lenders in your area are offering. Then, weigh that against how much profit you expect the property to generate to get a sense of your potential return on investment.
Check out the borrowing requirements to see how likely you are to qualify for a loan. Finally, consider the timeline of your project. Will you be able to repay the loan within the time frame specified by the lender? If not, would you be able to refinance a hard money loan into a conventional mortgage if necessary? Thinking about the bigger picture can help you avoid any mishaps when taking the hard money route to fund your investment plans.
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