A hard money loan is a short-term financing option ideal for real estate investors who need to move quickly. The term “hard money” has historically referred to a currency that is backed by a tangible asset or commodity (think gold, precious metals). With a hard money loan, the tangible asset is the property used as collateral. As the name may suggest, hard money lenders are more concerned with the underlying value of a property rather than the individual creditworthiness of the borrower taking out the loan.
How is a Hard Money Loan Structured?
Given the unconventional nature of this loan product, hard money loans have loan terms that differ greatly than a loan you would get from a traditional bank. Rather than a 15- or 30-year mortgage, hard money loans typically have a term from six to 12 months. While this varies lender to lender, these loans typically involve interest-only payments for the duration of the term with a balloon payment at maturity. Since hard money loans are riskier than traditional financing options, interest rates on these loans will be higher. By design, hard money loans are usually used as bridge loans. Investors take out hard money loans to “bridge” the gap between different transactions and providing immediate access to capital.
The two examples below illustrate scenarios where hard money loans enable savvy investors to execute their real estate strategies.
Example Hard Money Loan Scenario #1
Jon has Property A listed for sale, and is actively searching for another property to acquire. He identifies Property B as his next investment. Property A is set to close in two months, but Property B is an excellent opportunity garnering significant interest from other investors in the area. In order to capitalize on the opportunity, Jon uses a hard money loan to purchase Property B and secure the deal without having to wait two months to use the proceeds from the sale of Property A. Since hard money loans can be approved and funded in a matter of days rather than months, he is able to act swiftly not lose out on any good deals they find. Two months down the line, Jon finalizes the sale of Property A and uses the proceeds to pay off the hard money loan on Property B.
Example Hard Money Loan Scenario #2
James plans to use the BRRRR Method. He identifies a distressed property that has potential. Given the condition the property is in, James struggles to find a bank/credit union willing to lend on the property. He turns to a hard money lender aligned with his investment strategy that sees the underlying value in the property. After acquiring the property and completing renovations, he is ready to refinance into a more permanent financing solution. James then uses a cash-out refinance to pay off the balance of the hard money loan (and secure some additional cash-out through the value he’s added to the property through renovations).
Since the focus is the property rather than the borrower, individuals will typically have an easier time qualifying for a hard money loan. As stated previously, Unlike traditional bank loans, hard money lenders base their decision on the property value. This allows for faster approval times and investors can acquire their projects within days. Hard money loans typically have higher interest rates and shorter repayment terms. This makes these type of loans more risky, but potentially more rewarding for ventures like fixing and flipping houses.
What are the Benefits of Hard Money Loans?
Hard money loans have plenty of upside for investors who know how to use them well. The biggest advantages of using a hard money loan are the speed with which they can be funded and the overall flexibility of the loan product. are best suited for specific situations, particularly those involving real estate where speed and flexibility are crucial.
Quick Access to Capital
Hard money loans excel in situations where investors need to purchase a property before competitors. Hard money loans are often approved within days or weeks. In fast-paced real estate markets, quick access to capital is crucial. The ability to capitalize on time-sensitive opportunities is a massive plus for investors.
Flexibility in Qualification
Borrowers with low credit scores or limited financial history may struggle to secure traditional financing. Hard money loans offer alternatives for these borrowers. With the loan product being focused on the value of the collateral (property), it is significantly easier for more borrowers to qualify.
Flexibility in Terms
If you need temporary financing to overcome a gap, such as a bridge loan, a hard money loan can provide a quick solution. Traditional lenders might be hesitant to finance properties in poor condition or with unique features. Hard money lenders are more open to lend on fix and flip properties if they see potential and are secured by the property’s value.
It’s important to remember that hard money loans are not without drawbacks. The higher interest rates and shorter terms make them risky if not managed carefully. It’s crucial to have a solid exit strategy and ensure you can repay the loan within the timeframe to avoid potential defaults and asset seizure. Hard money lenders generally offer more flexible loan terms. This allows for customization based on the specific needs of the project.
Hard Money Loans vs. Traditional Mortgages
How do hard money loans stack up against conventional financing? While both objectively serve the same purpose in that they are used to acquire real estate, there two are distinctly differentiated. Highlighted below are the key differences between these financing options.
Source of Funds:
- Hard Money: Funded by private individuals or investment groups.
- Traditional Mortgage: Funded by banks and sold to investors on the secondary market.
Approval Criteria:
- Hard Money: Primarily based on the property’s value and potential with less emphasis on credit score.
- Traditional Mortgage: Heavily reliant on borrower’s credit score, income verification, and employment history.
Loan Terms:
- Hard Money: Typically short-term (6 months – 1 year) with interest-only payments and higher interest rates (9%-12%)
- Traditional Mortgage: Long-term (15 – 30 years) with fully amortized payments and lower interest rates (currently around 7%).
Loan Purpose:
- Hard Money: Often used for quick real estate transactions like flipping houses.
- Traditional Mortgage: Primarily used for purchasing a primary residence.
Overall:
-
- Hard Money: Faster approval, good for quick deals and borrowers with weaker credit, but comes with higher costs and risks.
- Traditional Mortgage: More affordable option for long-term homeownership, but requires strong creditworthiness and a longer approval process.
About Easy Street Capital
Easy Street Capital is a relationship-based investment real estate lender with loan programs for every borrower. Regardless of experience or credit we are able to finance your next investment property. Whether you are buying a property to fix up, building new construction, or generating cash flow from rental units, Easy Street Capital has the solution.
As a fully discretionary lender we have the ability to customize a loan specifically to meet your individual needs. We look forward to assisting you with your next project.
Contact us today to begin your next real estate project!
Request a Hard Money Term Sheet
About the Author
- Fix and Flip - December 20, 2024
- Fix and Flip - December 19, 2024
- Fix and Flip - December 17, 2024
Stay in the Loop
Subscribe to our newsletter