There are a lot of misconceptions about hard money lenders: what they are, what they aren’t, how much they cost, and when you should use them. Hard money lenders are neither thieving opportunists nor last-minute saviors, but they are a resource that can sometimes be the right fit for a real estate deal.
What is a hard money loan?
Hard money, or private money, is exactly that: non-institutional money that can be borrowed, usually from an individual or an extremely small lending company. They are an alternative to a bank or traditional mortgage lender, and their loans are typically much different.
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- This is not a loan. These tax credits do not need to be repaid
- Hard money lenders are expensive. They typically charge interest rates in the teens, and charge at least 2-3 points and sometimes as many as 7-8. Clearly, this is not a loan for Joe Homeowner.
- They typically lend for very short terms. This could be anywhere from a few months to a few years, but seldom longer.
- They lend at extremely low loan-to-value ratios (LTVs), meaning that they will only lend a small fraction of the value of a property. If the real estate appraises for $100,000, they might only lend $60,000.
Advantages of hard money loans
With all of that being the case, why would anyone use them? There are several advantages, offsetting all of those disadvantages. To begin with, they are much faster to act than the average bank, often able to close a loan in less than a week. This makes them a good choice for distress sales and other scenarios where an investor has an opportunity to buy low but only within a short window of time. Second, they are collateral-based lenders, focusing first and foremost on the equity position of their lien, and scrutinizing the borrowers themselves far less heavily. That means that they will lend to borrowers with bad credit, borrowers who can’t document income and other difficult borrowers because they are only lending such a small fraction of the value of the real estate.
When to use a hard money lender
So when is it a good idea to use a hard money lender? As a general rule, homeowners should not borrow from hard money lenders, as the loans are expensive and temporary. Seasoned real estate investors, however, who know the game well, may decide that it is worth the expense in order to quickly buy a house for a bargain. If banks won’t lend to them due to credit or income, investors may not have a choice but to use a hard money lender to invest in real estate. Hard money loans are also particularly well-suited to renovation and construction loans because hard money lenders tend to be so much more responsive and flexible. Landlords who buy shells, renovate them and then rent them out must be prepared to refinance as soon as the renovation or construction is finished, however, because the interest rates are so high.
Hard money lenders can be a useful resource for the wise real estate investor, but all investors should take a good look at their local banks first, as some local banks can offer the same speed, flexibility and quality of service as a hard money lender at a fraction of the price. Real estate investors are wise to try to establish a relationship with both a local bank and a local hard money lender to keep their options open and to find the best fit for each real estate deal that they make.