Hard money lending: Guide to hard money loans and lenders
Key takeaways
- Hard money loans are secured, short-term loans often used to finance a home purchase.
- Real estate investors commonly rely on hard money loans to manage multiple flip projects.
- Hard money loans deliver cash quickly but at a higher interest rate compared to other types of financing.
Hard money loans are a way of borrowing funds over the short term. They’re especially popular with real estate investors, but they can also be a good tool for borrowers with assets, but poorer credit. Here’s what you need to know.
What is a hard money loan?
Hard money loans, also called bridge loans, are short-term loans commonly used by investors, such as house flippers or developers who renovate properties to sell. They might also be a solution if facing foreclosure.
Hard money loans are usually funded by private lenders or investor groups, rather than banks, and use equity or real property as collateral.
How does a hard money loan work?
Hard money loans are secured by the property they’re tied to instead of the borrower’s credit and financial profile. The loan is typically based on the property’s value and comes with a short repayment term, usually less than a year.
For this reason, they’re often sought out by those who buy homes with the intent to fix them up and sell them quickly. This presents an opportunity for the hard money lender, who (in theory) can count on getting repaid within a relatively short time.
Some hard money loans are structured as interest-only loans, followed by a large balloon payment. This makes them riskier than other kinds of financing.
Hard money loans vs. traditional mortgages
Hard money loans are different from typical mortgages for several reasons. For one, they tend to be faster to apply for, and close quicker, too. Additionally, the repayment term on a hard money loan is much shorter than the more popular 15 or 30 years for a mortgage.
“They are underwritten differently and have different requirements, and they are usually short-term, with some lasting as little as six to 18 months,” says Jeff Shipwash, CEO of Shipwash Properties LLC, a home-flipping company in Knoxville, Tennessee that often uses hard money lenders for its projects.
Hard money loan interest rates are also usually much higher than those for a traditional mortgage.
“Also, unlike a traditional mortgage, the value in a hard money loan deal is factored into the underwriting much more than the borrower’s credit score,” says Shipwash.
Lastly, hard money lenders require a down payment, often one that’s a higher percentage than a traditional mortgage — think 20 percent at minimum, or 30 percent or more. A conforming conventional loan can be had for just 3 percent down.
Hard money loans are also different from so-called soft money loans:
- Hard money loans are usually secured by physical assets like property and their assessed value in the form of equity. “Hard money loans are generally non-recourse,” says Mills Menser, CEO and founder of Diamond Banc, headquartered in Columbia, Missouri. That means if the borrower doesn’t repay the loan, the outcome is simply forfeiting the pledged asset.”
- Soft money loans are backed by the borrower’s credit. They “obligate the borrower to repay the total sum of the amount borrowed, and considerations such as creditworthiness and repayment ability are generally heavily weighted,” says Menser. “Also, with soft money loans, the borrower is responsible for the debt in the event of default, until the debt is satisfied.”
What to expect from hard money lenders
Hard money lenders work differently than traditional loan lenders. If you’re thinking about working with a hard money lender, there are a few things to know first:
- Similar to payday lenders: Like payday lenders offering personal loans, hard money lenders have little oversight or regulation to adhere to, says Bruce Ailion, a real estate attorney and Realtor in Atlanta.
- Higher interest rates: Hard money loans come with greater risk for the lender, which translates to a higher interest rate for the borrower. “Lenders can charge what they want for the risk they take in making a loan,” says Ailion.
- Shorter loan terms: Hard money loan terms typically range from a few months to a few years.
- Different rules: Hard money lenders are free to set their own requirements on things like credit scores and debt-to-income (DTI) ratios.
Who is a hard money loan best for?
The types of borrowers who tend to get hard money loans include:
- Borrowers who don’t qualify for traditional loans
- Homeowners facing foreclosure with substantial equity in their home
Property flippers
People who buy properties to renovate and resell them for a profit, known as property flippers, will often get hard money financing, says Julie Aragon, a Los Angeles-based mortgage expert with Arbor Financial Group.
“Property flippers like hard money loans because they can get the cash fast,” says Aragon. “This expediency is beneficial when they’re bidding on a property. They will have the advantage over someone who might need a month to close.”
Borrowers who don’t qualify for traditional loans
There are many reasons some borrowers don’t qualify for a traditional loan, such as a 30-year fixed-rate mortgage from a bank. These reasons might include a recent divorce that affected their credit score or the inability to document their income. For business owners, too, proving income can sometimes be challenging.
“Self-employed people who write everything off might be able to afford a mortgage, but their taxes don’t reflect that,” says Aragon. “For them, hard money loans are their only option.”
Homeowners facing foreclosure with substantial equity in their home
Although this isn’t a common scenario, some homeowners have a lot of equity in their homes but are at risk of foreclosure. Hard money lenders would consider lending in this situation if they can be assured that, should the loan go into default, they can sell the house, pay off the first mortgage and still earn a profit from the sale.
Pros and cons of hard money loans
Before you decide to work with a hard money lender, consider the pros and cons of this financing option:
Pros of hard money loans
- Flexible loan terms: Hard money lenders tend to be flexible when it comes to negotiating loan terms. They don’t have to adhere to the same regulations that conventional mortgage lenders are subject to.
- Speedy funds: Compared with the glacial pace of traditional mortgage underwriting, hard money loans can be processed in just days. For real estate investors, speed can sometimes make all the difference when it comes to closing a deal — for example, when bidding on a competitive property at auction.
- Don’t require a strong credit history: You don’t need a good credit score or loads of financial documentation to get a hard money loan. While traditional mortgage underwriting focuses on borrower income and credit history, hard money lenders extend loans based on collateral, such as a house or building. For this reason, hard money lenders need to know the estimated market value (after-repair value) of the property after the planned renovations are completed.
Cons of hard money loans
- Higher cost: Hard money loans are costly compared to traditional loans. The interest rates can be several percentage points higher than for conventional mortgages, and the upfront fees are also expensive (as high as three to five points or more). Closing costs are likely to be steep as well, and there is a significant down payment requirement. In addition, you could be charged a prepayment penalty if you pay your loan sooner than the term dictates, which can add to costs.
- Conservative loan-to-value (LTV) ratios: You’ll need significant assets to qualify for a hard money loan. Hard money lenders typically require a loan-to-value (LTV) ratio of about 50 to 70 percent. That’s a lot more conservative than for conventional mortgages. For instance, Fannie Mae guidelines specify an LTV ratio from 75 percent to as high as 97 percent.
- Hard money lending regulations: Hard money lenders are subject to federal and state laws that bar them from lending to those who can’t repay the loan. By law, hard money lenders have to establish that a borrower has the means to make the monthly payments and any scheduled balloon payment.
How to get a hard money loan
Once you have a down payment and have decided to get a hard money loan, there are a few steps you need to take, like finding a reputable hard money lender and applying for the loan.
Find a reputable hard money lender
Finding a hard money lender is not the same as finding a traditional financial institution to give you a loan. Here are a few of the most common ways to find a hard money lender:
- Get a referral: If you know people who work in real estate, such as a real estate agent, settlement agent or real estate attorney, they may be able to refer you to a hard money lender.
- Talk to a title office: “Title offices record loans for hard money lenders regularly and can give you referrals to hard money lenders who lend in your area,” says Robert Taylor, a full-time real estate investor in Sacramento.
- Search online: Another option is to search online for a lender.
Apply for a hard money loan
Once you’ve found a hard money lender, here are the steps to apply:
- Gather documentation: Pull together all of your documents, including identification, income information, bank statements and other account statements.
- Know how you’ll repay the loan: Since hard money loans have a short repayment term, you need to know how you’ll repay the loan.
- Compare lenders: Compare offers from multiple lenders. Look at the interest rate they charge, as well as the associated fees. You can do this by comparing the interest rate versus the APR.
- Contact the lender and apply: Talk with the lender and submit an application, answering any questions it has and providing the required documents.
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