Hard money loans are a type of financing where a borrower receives money based on the value of a piece of real estate, not his or her credit worthiness. Hard Money Loans are issued at a much higher interest rate than standard real estate loans, and are almost never issued by commercial banks. Due to this, these loans are sometimes issued by private individuals and are potentially very risky. Typically used in turnaround situations, short-term financing and to stave off foreclosures.
Hard money loans are generally considered loans of “last resort,” and is initiated when a borrower with a poor or limited credit history can find no alternative to conventional financing, or when a borrower needs turnaround financing quicker than conventional sources can provide, such as in the case of foreclosure, bail outs, delinquency and loan restructuring.
Individuals who need funding loans for non-conventional property purchases, such as land, property in a rural area, land development or construction projects, etc. may be hard-pressed to get traditional financing, and are forced to turn to hard money lenders. Additionally, real estate investors seek out hard money loans because the loan can be approved and funded in as little as four days, an important factor when a property is being flipped and held for only a short time.
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The hard money loan amount and interest rate assessed is based solely on the appraised value of the property and not on the borrower’s creditworthiness or personal guarantee. The amount of the approved loan is based on Loan to Value (LTV) ratios that are often significantly lower than conventional real estate loans. Sometimes referred to as a “bridge loan,” the hard money loan is intended for short term financing needs.
Providers of hard money loans are generally private investors or lenders, and the risk they take is significantly higher than traditional lenders. To mitigate that risk, hard money lenders charge higher interest rates (up to 18% p.a.) and real estate related fees (closing, appraisal, document preparation, recordation, etc.), and offer loan amounts based on a significantly lower loan-to-value ratio, sometimes as little as 65% of the appraised amount. Potential borrowers must have substantial equity in the collateral property, enough to cover the loan in the event of foreclosure.
Hard money loans, with their low LTV ratio combined with high interest rates and fees may seem unattractive to most consumers, but there are benefits such as a quick turn around of the loan, sometimes in less than a few days, and the elimination of the red tape and restrictions required by traditional lenders.
Sources:
http://www.bankrate.com/brm/news/mtg/20000831.asp
http://www.investopedia.com/terms/h/hard_money_loan.asp
