As a broker that deals with both commercial and residential financial products, we often work with borrowers who take out hard money loans. But what are hard money loans and why do they exist? What are the pros and cons of hard money loans and who might stand to benefit from of these rather intimidating-sounding products? Today, we’ll answer all your burning questions about hard money loans so that you know when to use them to your advantage and when to avoid them at all costs.

What Is a Hard Money Loan?

Hard money loans offer borrowers a way to obtain financing while circumventing traditional lenders. Instead of working with mortgage lenders, for example, you would borrow from individuals or investors who lend based on what you have, not who you are on paper. Instead of looking at your credit history, a hard money lender allows you to collateralize your loan with real property (which is considered a “hard” asset). What can you use as an asset to secure a hard money loan? An existing home (in which you have substantial equity), a car, or even a boat, for example, are good examples of collateral.

Rather than the typical lengthy terms attached to mortgages, the terms for hard money loans are quite short in comparison. These loans are instead offered with payback terms that vary from six months to five years. While mortgages and traditional loans generally offer competitive interest rates, the rates for hard money loans are typically higher.

What Are  the Pros and Cons of a Hard Money Loan?

The Pros of a Hard Money Loan

Despite the pun employed in the headline, hard money loans can often be much easier to obtain than traditional loans, and they can close very quickly since there is less to verify and fewer hoops to jump through. They can often be secured in just days, versus the typical months it takes to secure a traditional loan these days—this speed can be a huge advantage when you’re trying to buy a property with multiple offers on the table.

You can also frequently borrow the entire value of the property you’re purchasing. So, if you want to purchase a property that’s $200,000, you could potentially get a loan to cover that entire amount. While some lenders will want to see that you have experience in real estate development (if that’s why you’re borrowing), others won’t care.
The payment terms on a hard money loan are much more flexible—or at least, they can be. This is because the lender isn’t beholden to the regulations and guidelines that can prevent traditional lenders from tweaking terms. Hard money lenders can adjust repayment schedules and other conditions of the loan in ways that other lenders can’t.
In addition, while your credit history, income, and experience may matter, these factors are not nearly as important as they are to traditional lenders.

The Cons of a Hard Money Loan

This all sounds great, right? So, what’s the catch? The rates are considerably higher—so you wouldn’t want to use hard money loans as long-term borrowing tools—and there are often origination fees involved, too. And, of course, if you default on the loan, the lender can seize the property you put up as collateral. What’s more, a sizable down payment may be required and there are often pre-payment penalties attached.

When Might a Hard Money Loan Be a Good Idea?

Mortgage loans and other types of loans used to be relatively easy to obtain. However, ever since the housing market collapse, there have been many additional restrictions placed on lenders in an effort to prevent a similar crisis from happening again. These financiers themselves are more cautious about lending money now as well, given that new regulations have been introduced. This all means that it’s significantly tougher and much more time-consuming to be approved for and sign on a residential or commercial loan. As mentioned above, hard money loans are used in quick-turnaround situations as well as in circumstances in which you can’t get traditional financing.

Quick Turnaround

When a developer or house flipper needs cash right away to fund a property deal, they can secure money very quickly, often within a few days. Once you’ve established a relationship with a hard money lender, the borrowing process becomes even more streamlined. This makes a hard money loan a great option for developers and investors. Because they generally only need to hold onto properties for short time periods, they aren’t heavily burdened by the high interest rates attached to these loans and are often able to recoup the interest they’ve paid (and make money to boot) when they sell (or begin renting out) their investment properties.

Bad Credit

As mentioned above, hard money loans can be a good option for those with bad credit. If you can offer your existing home up as collateral, you’ll often be able to secure a hard money loan to avoid foreclosure, buy a home, or to begin investing in additional properties as a way to bring in some income. Be aware though, that hard money loans’ high interest rates can create slippery slopes for those with poor money-management habits. If you’d like to use a hard money loan to turn your financial situation around, be sure to consult with a broker who can also serve as a financial planner (like Villa Nova Financing Group!), who can help you determine if a hard money loan is a good move for you.

Inconsistent/Self-employed Income

Self-employed individuals often find it difficult, if not impossible, to obtain a loan. This is because, while independent contractors benefit from being able to write off much of their income (and thus avoid being taxed on that income), it’s also hard for those who show little taxable income to qualify for loans. Hard money loans are an option for those who don’t show enough income or whose income is too inconsistent to qualify for a loan. If you’re self-employed, a hard money loan may be the best chance you have of buying a new home (assuming you have assets to put up as collateral).

Hard Money Loans in a Nutshell

While hard money loans are extremely useful financial tools for real estate developers and investors, others need to think carefully about whether hard money loans are right for them. These loans are often called the loans of last resort. If you’re about to enter foreclosure, a hard money loan may bring you back from the brink (assuming you’ve built up enough equity to offer your home as collateral). If you can’t qualify for a traditional loan, a hard money loan could help you secure the funds you need by enabling you to use your existing hard assets as collateral.

The high rates and short terms make them a good vehicle for short-term investments such as fixing up and flipping houses and not so good for traditional home purchases (unless they are your only option).

Is a Hard Money Loan Right for Me?

It’s a question every individual considering a hard money loan must ask themselves. It all comes down to your comfort level with higher-risk loans, your confidence that the property you’re purchasing as an investment will turn a profit (or, at the very least, enable you to break even) OR that you’ll be able to repay the loan, and your willingness and ability to cope with the inevitable stress that comes with taking out a high-rate, short-term loan. If you’re disciplined, motivated, and have a clear plan for repaying the loan, a hard money loan can be a very helpful and flexible borrowing tool.