The pros and cons of hard money loans
Private money or hard money loans are loans given out by private companies or individuals to the borrower on a short-term basis. Unlike the regular loans from banks, these loans are given privately and do not consider the borrower’s financial history. However, it considers the current physical assets.
Typically, hard money loans are asset-based loans used mainly by real estate investors. The borrower gets the loan but, in exchange, uses a physical property as collateral. The loan usually lasts up to a maximum of three years and is often processed quickly.
Who borrows the hard money loans?
Like most short-term bridge loans, hard money loans are often used in the real estate industry. They are common among house flippers who buy properties and sell for a profit. These investors take the loan to renovate or develop properties and, in turn, sell once there’s a ready market.
Individuals purchasing investment properties like rentals and cannot qualify for bank loans may also take the hard money loans. Similarly, entrepreneurs and business owners might use these loans to buy commercial real estate properties. This is common when such persons find that traditional bank loans limits are insufficient and cannot meet their needs. Most homeowners facing foreclosure can also opt for hard money loans. Thanks to the short processing times and minimal hard money loan requirements.
What you need to qualify for hard money loans
The requirements for securing a hard money loan usually vary from one lender to another.
Room for negotiation is often available, depending on your relationship with the lender and based on your property’s value.
Here are some of the things that will boost your odds of qualifying for a hard money loan.
- Down payment. To qualify for the loan, you must have the required down payment or equity in the property to be used as collateral. The value of the down payment will vary from 10% to 50%. So, you always want to compare options in the market.
- Familiarity with real estate. Most borrowers going for hard money loans are investors in the real estate market. So, experience plays a major role in getting your loan approved. First-time investors might have a hard time getting the loan. They will also be required to give more details about the project and demonstrate how they can repay the loan if their project fails.
- Your overall financial Muscle. While private money lenders don’t base their decision only on this factor, it still plays a major role. This is especially true when the property used as collateral isn’t in a strategic location. Or when the market is turbulent, and the demand for hard money loans is higher than the supply.
What makes the hard money loans attractive
Several factors make hard money loans attractive to a larger population of real-estate investors. Here are of them:
- Faster approval process. Lenders of hard money loans usually have their simple criteria of evaluating whether or not to give a loan. The approval time is usually short since they majorly consider the property given as collateral or the ROI. So unlike banks that take up to a month, private money lenders typically take 24 hours to two weeks.
- Flexibility. Bureaucratic rules do not govern private money lending; hence decision-making is quick to make and change. For instance, the decision-makers can modify the repayment terms to fit your needs, provided it’s a win-win.
- It finances fix, and flip properties. For real estate investors, this is a big deal. Fix and flip properties are often outdated and vacant, and most banks aren’t willing to finance. And even though such investments are risky, private money lenders know they offer a high-profit margin.
Red flags of hard money loans
Besides being fast, convenient, and reliable, hard money loans come with their fair share of disadvantages. We’ve listed them down below:
- High-interest rates. Compared to loans from banks or credit unions, hard money loans command a high-interest rate. The typical hard money loan rates range from 7% to 12%. This is because the lender is taking the risk of lending on a distressed property. Since the lender has no borrower’s financial history, it increases the risks, hence higher interest rates.
- High down payments. Most private lenders require borrowers to pay a down payment of 25% – 30% for residential properties and 30% – 40% for commercial ones. This is much higher compared to banks which take a 20% down payment.
- It’s a short-term loan. Hard money lenders focus on short-term loans to reduce the risk involved. As a borrower, you will need to have a strategy to repay your loan within the period agreed. That way, you can avoid being charged an extension fee.
The decision to go for a hard money loan is good if you need instant money to invest in a promising real estate project. Even so, you need to have a backup plan in case things don’t go as planned. If you are going for a hard money loan for purposes other than an investment that can pay back within three years or less, you may want to consider other options.