How Does a Hard Money Loan Financing Work

Using hard money financing is a way of borrowing funds without using traditional lenders. When a person needs a loan quickly and gets rejected by the bank, they often turn to hard money lenders. 

Hard money loans are, in fact, private loans that come from investors or individuals. However, many people choose private lenders over traditional banks and mortgages for many reasons, not because they are their only option. 

The terms and conditions of hard money loan financing are beneficial to some professionals, like real estate investors. 

But what is private money loan financing and how does it work? 

Let’s start with the basics. 

What Is a Hard Money Loan? 

While traditional lenders require you to secure your mortgage by your ability to repay it over 15 to 30 years, hard money lenders take a diverse approach. Instead of asking for proof you can repay, they will base the loan on the property’s value. If anything goes wrong and you don’t repay the loan, the lender will get their investment back by selling the property. 

Since the property is the collateral, its value is far more critical to a private lender than your credit score or income. 

In general, hard money loans are short-term, lasting from six months to five years. And since interest rates are higher than those of traditional loans, you wouldn’t want to keep them longer anyway. 

There is a significant difference in the approval process, loan purpose, and terms between hard money loans and traditional mortgages. Hard money loans require much less documentation in the application process, take significantly less time to get approved, and are commonly used for specific purposes. 

Why Use a Hard Money Loan?

If hard money loans come with high rates, why would you use them? Private loans have their place for specific borrowers for several important reasons: 

Speed

A private lender focuses on collateral and is less concerned about your credit score and financial situation. Therefore, hard money loans close much quicker than traditional loans. It is significant for people who need to get a loan as quickly as possible. 

Flexibility

Private money agreements are far more flexible than traditional ones. Since they don’t use a standardized underwriting process, hard money lenders can evaluate every deal individually. Some lenders allow you to tweak some things in the agreement depending on your specific situation. Remember, you are likely borrowing from an individual or organization willing to talk and accommodate you. 

Approval

The most critical asset to hard money lenders is the property’s worth. If you want to invest in a new property, a private lender will lend you funds equal to the property’s price.  Negative credit report items are less significant for approval. Moreover, some lenders don’t even look at your credit. 

Who Uses Hard Money Loans? 

Real estate investors mostly use hard money loans. Their profession requires them to work in a fast-paced market and they often need funds fast to close an investment deal. Good deals always go fast and being able to get cash within several days means everything. 

If an investor doesn’t have access to cash, their offer isn’t competitive. The seller would always rather see the money sooner than later. 

Investors typically use hard money loans for one of the following purposes:

  • To get funds quickly for fix-and-flip projects 
  • To successfully bridge the gap between long-term financing and quick investment purchase. Investors buy and renovate a property and then refinance with a traditional lender to pay off the private money debt. 

Over the past decade, hard money loans have become the most crucial financing option for house flippers, especially those who can’t borrow from a bank. Sometimes, the reason is bad credit. Other times, the traditional lender doesn’t find the deal interesting enough. Frequently, however, investors skip the conventional lenders and go straight to asking for a private loan because they need it quickly. 

Pros and Cons of Hard Money Loans

Like any other type of financing, hard money loans have their pros and cons. Here are the most significant ones, summarized: 

Hard Money Pros 

  • Quick closure
  • The property value is the only collateral – in some cases, the borrower isn’t personally liable for repayment. 
  • Approval doesn’t depend on the creditworthiness
  • Low loan-to-value ratio
  • Suitable for use as a bridge loan

Hard Money Cons

  • Higher interest rates compared to traditional lenders
  • Common additional fees
  • Finishing rehab on time is essential. Otherwise, the hard money loan becomes utterly expensive
  • The lender requires building risk insurance – which is expensive
  • Sometimes, the loan isn’t enough to finish the renovations if there are unforeseen expenses.

Conclusion

Hard money loans aren’t for everyone, but those who use them know how to make the most of it. Before deciding what kind of a loan you need, do your research and find reliable private lenders with a reputable history and many satisfied borrowers under their wing.