What Is a Hard Money Loan and How It Works?

What Is a Hard Money Loan and How It Works?



A hard money loan refers to a type of loan. However, what makes it different from other types of loans is that it’s secured on real property. Moreover, they are considered short-term bridge or last resort loans. Basically, they are used in different real estate transactions. The lenders are either companies or individuals, not banks. Read on to know more.


Key Takeaways


Given below are some of the salient features of these loans.



  • Primarily, they are used for real estate transactions. And this money comes from a company or individual instead of a bank.



  • Typically, this type of loan is granted for a short period of time. The purpose is collect money quickly at a lower ration of LTV and higher cost.



  • Since these loans are not executed traditionally, the funding time is reduced is usually quite quick.



  • It’s interesting to note that the terms of these loans are negotiated between the borrower and the lender. Plus, these loans use the real estate as collateral.



  • Although repayment may result in default, they still leave a lot of profit for the lender.


How does a Hard Money Loan Work?


Usually, the terms of hard money loans are based on the value of the real estate, not the borrower’s creditworthiness. Since conventional lenders like banks are not the lenders, private lenders or firms are most interested in this business.


Also, these loans may be a good choice for property flippers who have plans to renovate a property and sell it again. Here you may be thinking the cost of this type of loan is quite high. But the good thing is that the extra cost is offset by the loan will be paid off rather quickly. In most cases, the loan is granted for a period of 1 to 3 years. Aside from this, they offer a lot of advantages as well.


Aside from this, this type of loan is considered a great investment as well. You can find a lot of people out there who have done this business and are happy with the practice.


Special Considerations


Typically, unlike the bank financing or the financing programs offered by government, the cost of these loans is quite higher for a typical buyer. However, this cost reflects the higher risk that the loan granter bears. But the great thing is that the extra cost is a worth it as the money is available quickly. The approval process is less stringent and the repayment schedule is also quite flexible.


Also, these loans can be a great choice to deal with turnaround situations. For instance, if you need money quickly for a short-term financing but you have poor credit score, you can give it a go. Since the amount is issued pretty quickly, you can use the funds to stave off a foreclosure, for instance.


Pros and Cons


Now, let’s take a look at some pros and cons of hard money loans.


Pros


First of all, the approval process is quite faster unlike the process of mortgage or a conventional loan. The thing is that private lenders are interested in this type of business as they can make decisions quickly without running a lot of checks. In other words, they won’t check your credit history. These are the steps that slow down the process and make the borrower wait for weeks.


Typically, these investors only care about the repayments. Plus, they have the opportunity to resell the property in case the borrower fails to make payments and becomes a defaulter.


Another advantage is that the lenders don’t apply the conventional underwriting process. Instead, they evaluate all of the cases one by one. Often, applicants can sit with the lender and discuss the repayment schedule based on their circumstances. Aside from this, borrowers can take advantage of a lot of opportunities during the time they have. So, this is another great advantage you can enjoy if you go for this option.


Cons


Since the real estate is used as a security against default, these loans feature lower LTV rations unlike the regular loans. This ration is between 50 and 70% unlike the ration of regular loans, which is 80%. However, if you are an experienced flipper, it can be even higher.


Aside from this, the interest rates of these loans are higher as well. For subprime loans, the rate of interest can be even higher. In 2019, for instance, the rates of hard money loans were between 7.5 and 15% based on the period the loan is granted for. By contrast, the prime interest rate was only 5.25% in the same period.


Another disadvantage is that these lenders may not offer loans against owner-occupied property because of compliance rules and regulatory oversight.


Hope, now you understand what hard money loans are and the pros and cons associated with them. For more information, you can consult your mortgage broker.




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