When you are preparing to offer your property as collateral for a loan, you will find that many companies are eager to loan you the money you need. However, the property you are putting up as collateral must have a higher value than the loan amount. Hard Money lending allows individuals to borrow money without using a traditional mortgage lender and instead comes from investors willing to provide the funds needed. This article will discuss what a hard money loan is and the advantages and disadvantages of this type of loan.
What are Hard Money Loans?
These loans are called hard loans. Offering collateral will get you a loan from every financial institution and bank; however, banking entities generally have a long, drawn-out process to obtain funds. An individual or investment group that offers hard money lending will give you access to the money you need in a much quicker time frame. Funding occurs after the property details and ownership is authenticated. Hard money lenders view such loans as investments that will bring in a good return very quickly.
More About Hard Money Loans
Hard money lenders take a higher risk while offering the borrower the finances they need. As a result, the cost of such loans is more elevated. The advantage to the borrower is that access to additional capital is faster, does not have a stringent approval process, and most lenders will even offer flexible repayment schedules.
Hard money lending is a practice primarily followed in real estate, where the availability of ready financing is an advantage for closing property deals. The borrowers’ credit report does not play a part in the granting of such loans. All the lender is concerned with is the equity in the property and the authenticity of the documentation submitted. One such reason an individual may seek a hard money loan is to avoid foreclosure, house flipping, or any instance of a need for fast cash.
Most hard money loans are short-term loans that rarely exceed five years and are more likely to be for a year. When hard money loans are for an extended period, the borrower will generally pay a much higher fee. In this scenario, the borrower ends up paying double or triple the original loan amount.
Hard money makes sense only if it is for a short-term loan. This type of loan allows the borrower to get out of any immediate financial difficulty or to utilize funds they need and then quickly repay the money borrowed. A hard loan is often seen as a means to tide the borrower over until they can get back on track. In the example of someone flipping a house, the goal would be to repay the loan after selling the property.
You can use hard money capital to acquire an available property on the market and then look for refinancing to obtain a loan with a lower interest rate to repay the hard money loan.
Advantages of a Hard Money Loan
The most significant advantage of a hard money loan is that the approval process is much faster than applying for a traditional loan through financial institutions. The hard money lender focuses on the collateral value and will not be bothered with the borrower's financial condition or ability to repay. No time is wasted in scanning and verifying income and financial statements. It is only the property documents that will undergo scrutiny and authentication.
Lenders are rarely worried about hard money loans being repaid, as they have ensured that the property pledged with them as collateral is worth much more than the amount of the loan, including the interest. If a borrower defaults on the loan, the hard money investor will sell the property to regain the money they invested.
Disadvantages of Hard Money Loans
The only protection that lenders have when giving out hard money loans is the property they receive as collateral. As a result, most lenders will not offer more than 50 to 70 percent of the property's value. The amount of the loan vs. the property’s value protects the lender against possible market variations over time. An investor may offer higher amounts to a borrower who has worked with them before and has been prompt in returning loans. An experienced and successful house flipper of real estate may fall in this category.
Interest rates for hard money loans are high and will be even higher than those given for subprime loans. Subprime rates are higher than the prime rates and are in force for loans to individuals with poor credit. Prime rates are three percentage points higher than the rate of federal funds. As a result, hard money lending rates are in the range of 7.5 to 15 percent, which can be pretty daunting.
Hard money lenders aren't the biggest fans of property offered as collateral that the property owner occupies.
The Need to Use Hard Money
If hard money is so expensive, why then do borrowers use it? Individuals utilize hard money loans usually when they cannot get traditional funding quickly when they need it. The lender focuses on collateral and will never ask for detailed financial statements. They may ask a few basic details about taking out the loan, the project the money is funding and other small things to establish a relationship with the borrower. They will, however, make a detailed study of the property documents, verify the authenticity, and at times may even choose to inspect the property conditions. A property in run-down conditions may result in the borrower being offered lower amounts as a percentage of the property's market value. Most hard money borrowers will often go back to the same lender after repaying a previous loan when they need money again. In such cases, approvals will be even faster, and often more significant funding may be available.
In the case of hard money dealings, agreements are between the borrower and investor. But these agreements are rarely standardized and may be drawn up in whichever way the lender sees that particular deal. Repayment schedules can be as flexible as needed.
Drawbacks of Hard Money
Whether it is a mortgage or a hard money loan, any loan becomes an obligation that has to be honored. Hard money may be more challenging to repay due to the high-interest rates charged by the investor. It is simple, as an asset, your property, ensures that you and the lender are safe. As a borrower, you have to plan for the profits you expect and budget appropriately so the loan payment is timely. These plans must be realistic and not just optimistic to ensure the advantages outweigh any drawbacks. If you are looking at hard money as a lifeline, it is almost certain that you will lose your property to the individual or investor lending you money.
It is crucial to consider the costs of hard money loans before entering into any agreement. Hard money lenders will evaluate your property to determine the amount of money they are willing to invest rather than accepting the figures you provide to them. To add to that, the amount of money you receive is the perceived value. Depending on the situation and ability to repay the loan in a short amount of time, be sure to weigh your options of hard money lending vs. conventional lenders who will accept your property as collateral for an extended period.
Most people who take hard money loans are very sure of where their profit is coming from in the future, including Investors in real estate, who plan to sell any property they purchase at a profit using a hard loan. Remember you have to sell the property that you have purchased with the hard money quickly and not wait for many market upturns, even if you have to do so at a lower price. Interest can build up quickly, so the faster you can sell a property, the lower the amount of interest you will have to pay.
What Happens if I Can’t Repay My Hard Money Loan?
Defaulting on a hard money loan or any conventional loan can significantly impact your credit score. Regardless of the type of loan you choose, if you default on a loan, it can substantially affect your ability to obtain loans or credit in the future.
Defaulting on your hard loan repayment also means you lose the asset you put up as collateral. The lender can sell your property for any amount they choose to cover the loan’s value and any accrued interest. Unfortunately, this can mean a considerable loss to the borrower, even if the agreement allows the borrower to get the balance for sale minus the loaned amount and interest. The lender will have no interest in looking for the best price but will only see that his investment has been fulfilled.
Hard money loans can be a great way to help you achieve your financial goals. However, you must have a plan in place to quickly repay the loan. This type of loan should never be considered a long-term loan as the higher interest rates will end up leaving you with little to no profit in the end. Also, it is essential to remember if you are unable to repay your loan, you forfeit the property you put up for collateral. Before jumping into a hard money loan, be sure to look at the risk vs. the reward.
Hard money lending is a great way to obtain needed funds quickly. If you are a mortgage professional looking for hard money financing programs, join our platform today. For more information, contact Liquid Logics at 816-652-0301, or schedule a demo to see how we can help you.