Real Estate Investors:
Hard money loans are common in real estate investing. Banks and other traditional lenders are not comfortable lending on risky investments. They prefer lending on stable investments which they feel are more likely to pay the loan back.
Therefore, real estate investors who need financing to purchase distressed property have limited options. Investors who want to do a gut rehab or a quick property flip commonly use hard money loans.
Other real estate investors, who may be purchasing income properties, may use a hard money loan initially until they can stabilize the property. Once the property is stable, these investors will secure a more traditional mortgage at a lower interest rate and pay off the higher interest hard money loan.
Hard money loans are also used by individuals with a poor credit score who are unable to get a mortgage from a bank. Despite the poor credit, they may still have enough equity in their property to have the hard money lender interested in making a loan. This scenario can be seen when an owner is facing foreclosure on a property.
Pros of Hard Money Loans
- Since you are working with one individual lender or a small group of lenders, there are fewer hoops to jump through. Hard money lenders are not interested in your credit score or how much debt you have. They are only interested in how much value they see in the property since the property is the asset that will be backing the loan.
- Depending on your lender, you could have your loan in a few days or a few weeks. It could take one to three months to secure a more traditional mortgage.
- Traditional mortgages require you to put down a minimum of 5 percent of the purchase price. Banks prefer you to put down 20 percent of the purchase price, which will often give you better terms on the loan. If you put down less than 20 percent, you will often have to purchase mortgage insurance, which will increase your monthly mortgage payment.
- With a hard money loan, the lender may be willing to lend you 100 percent of the purchase price. Without a down payment, you would only be responsible for paying the origination fee and the monthly interest until you pay the loan off in full.
- If you have shown a history of honoring the terms of the contract and paying your loan back on time, or even early, the lender will likely want to work with you in the future. The lender may be willing to loan a greater percentage of the purchase price, reduce the origination fee or reduce the amount of time it would take to receive the loan.
- When you are just starting out, hard money loans allow you to purchase property with very little money of your own. Once you have established yourself as an investor, you may be able to secure a line of credit from a bank instead of using a hard money loan, which will have a much lower interest rate.
Cons of Hard Money Loans
- Hard money loans have much higher interest rates than traditional loans. Lenders are able to charge these rates because they know the borrowers have few options for financing. Interest rates between 10 percent and 20 percent are common.
- Since the lender is also taking a risk by loaning so much money, they want to make sure you have an incentive to pay it back quickly.
- An origination fee is a fee the lender will charge to process the loan. It is a percentage of the loan.