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Top 3 Advantages and Disadvantages of Hard Money Loans

Written by Posted On Thursday, 05 May 2016 21:02

Hard money loans are a type of real estate loan usually utilized by professional real estate investors. These experienced real estate investors understand the specifics of these loans, but more novice investors need to understand the pros and cons of hard money loans. Prior to applying for a hard money loan, a borrower needs to know the main advantages and disadvantages.

Top 3 Hard Money Loan Disadvantages

While many real estate investors couldn’t imagine doing business without the help of hard money loans, there are a few aspects of hard money loans that may be considered less than ideal.

1. Interest Rates For Hard Money Loans Are Higher Than Bank Loans

Interest rates on hard money loans are higher than traditional bank loans. The interest rates are higher because of the higher risk for the hard money lender. Hard money lenders don’t do a deep dive into the borrower’s credit, income or other aspects of a borrower’s record before approving a loan request, which is seen as taking on a higher level of risk. Hard money loan interest rates usually range from 9-14%. Hard money loans also have a fee for the loan origination called points, which represent a percentage of the total loan amount. The points will generally range anywhere from 2-4. Borrowers should do some research by checking rates and terms at a few different hard money lenders before committing to a loan.

2. Short Term Use Only

The majority of hard money loan terms are for 1 or 2 years. Terms of up to 3 to 5 years may be available in some cases but hard money loans are intended to be short term only.

A longer loan term represents more risk to the hard money lender due to the uncertainty of how interest rates will adjust by the end of the term. When interest rates decrease, the borrower is able to refinance the loan to a lower rate. If rates start to increase the borrower can keep their existing loan with the lower than current market rate and the hard money lender is forced to wait for the loan to become due. As the lender waits for the loan to become due, they are making less money on this loan than they could yield if they were to make a new trust deed investment today at higher rates. This risk incentivizes the lender to offer only short terms.

3. A Down Payment Or Equity Of At Least 25-30% is Required

Many novice investors and borrowers often view a down payment or equity requirement as an unfair hurdle that prevents them from being approved for financing. Hard money lenders have the ability to overlook various shortcomings and issues on a borrower’s record, but they to ensure that the borrower has enough equity (or down payment) in the property. A banks primary focus is on income, FICO scores and credit reports, while hard money lenders focus on the real estate collateral.

The hard money lender is essentially taking on all the risk without enough equity or down payment put in by the borrower. If something goes wrong with the property/project, the borrower may decide to stop making payments and walk away if they don’t have much invested. This is the last thing a hard money lender wants to happen. A sufficient down payment in the property incentivizes the borrower to stick it out regardless of the situation.

Top 3 Hard Money Loan Advantages

1. Fast Approvals and Funding

The speed of the approval process and funding of the loan is often seen as one of the biggest advantages of hard money loans. In many cases a hard money loan can be approved in the same day as the initial request. A hard money lender needs to briefly look into the following:

  • the basics of the subject property
  • the amount of down payment/equity the borrower has available
  • the borrower’s experience in real estate
  • how the loan will be repaid (exit strategy)
  • cash reserves borrower has available for holding costs

As long as everything seems reasonable in these areas, approval will most likely be granted.

Real estate investors and property owners who haven’t used hard money loans before will be amazed how quickly funding takes place compared to bank loans. It is possible for hard money loans to be funded with 3-5 days. This is ideal for real estate investors who need to move quickly on an opportunity with an investment property loan. Banks often take 30 days or longer.This quick funding has saved many deals for real estate investors when their original lender pulled out unexpectedly during escrow.

2. Few Requirements Necessary for Hard Money Loans

Hard money loans have few requirements, especially when compared to loans from banks. The requirements include having adequate equity in the property, an exit strategy, sufficient cash reserves for holding costs, and relevant experience if needed. Because there are fewer requirements, there is a higher likelihood of approval. Conventional lenders have long requirement lists necessary for qualifying.

There are many issues that will prevent banks from even considering lending to a borrower including recent short sales, loan modifications, foreclosures, and bankruptcies. Poor credit is another issue that prevents a borrower from obtain bank financing. Many conventional lenders won’t lend to borrowers who have 4 mortgages even if the borrower’s credit is exceptional with no other issues on their record.

Real estate investors who currently have negative marks on their record can still obtain financing from hard money lenders. The borrowers must have enough equity/down payment (at least 25-30%) in the property that serves as the security for the loan.

For a potential borrower buying an owner-occupied property, the borrower can purchase a property with a hard money loan and then repair any issues on their record or wait the necessary period of time to remove the issues from their record. After the issues are fixed, the borrower may be able to refinance into a lower cost conventional loan.

Conventional lenders are very unlikely to extend financing for home loans to self-employed borrowers or borrowers who have not been employed for at least 2 years at their current company. The borrower could otherwise be an excellent candidate for a loan, but the arbitrary requirements from the conventional lenders are inflexible.

In the situation where the borrower is lacking the 2 years of employment history at their current company, they could obtain short term hard money loan (1-3 years) in order to purchase the property. The borrower would be able to refinance into a lower cost conventional loan once they obtained the necessary 2 years at their current position.

3. Funding For Projects No Other Lender Will Touch

A hard money lender is able to provide loans in situations a bank would not even consider, such as fix and flip loan. Fix and flip loans involve an investor buying a property with short term financing, quickly making improvements and repairs and selling the property for a profit. Most investors would want at most a 12 month loan for this type of project. A 12 month loan is not something a bank would be able to offer. Conventional lenders want long term loans and prefer to collect a smaller interest payment for a longer period.

In some situations, a property may have various issues that would prevent it from qualifying for conventional financing. Such issues would include problems with electrical, plumbing or the foundation, which could cause the bank to deem the property as uninhabitable. Banks are very risk-averse and will not consider loans outside of their lending criteria. For an uninhabitable property, a hard money lender could extend financing so the borrower could purchase the property make the necessary repairs and then sell the property or refinance with a bank loan.

Article Source: North Coast Financial, Inc.

For any questions regarding hard money loans please contact Don at 760-722-2991 or This email address is being protected from spambots. You need JavaScript enabled to view it.

 

 

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Jeff Hensel

North Coast Financial, Inc. are hard money lenders in California with over 30 years of experience specializing in various types of hard money loans including hard money rehab loans, purchase loans, cash out refinance loans, bridge loans, fix and flip loans and construction loans.

www.northcoastfinancialinc.com/

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