An alternative type of loan, hard money loans, can provide financing in particular situations. If you need money fast or don’t qualify for a more traditional type of loan, you might consider hard money loans.
Below, we explore what a hard money loan is and its implications.
These loans are secured by real property rather than being secured by your creditworthiness as a borrower.
An individual or a private company provides hard money loans rather than traditional lenders. These are usually short-term and non-conforming. The loan is secured like a traditional mortgage because there’s a guarantee by the property that the funding is being used to buy.
The loan’s name comes from the fact that the tangible asset, aka the property, is used to back the loan’s value. If you default on a secured loan, the lender can take the asset over to regain their losses.
Hard money loans usually have an easier and faster approval process—much more so than traditional mortgages and other types of secured loans.
With a mortgage, it can take more than a month from the time you apply to when you close to buy a property. If you get a hard money loan, you might be able to close in a few days.
Working with Hard Money Lenders
A private investor or company specifically working in this type of lending is who you would go to for a hard money loan. You’re not going to find this option by going to a local bank. These lenders don’t have to follow the same stringent regulations that conforming lenders do, so they can decide who they want to lend.
Hard money lenders set their own debt-to-income ratios and credit scores. Even if a traditional lender denies you, a hard money lender might give you a loan.
The biggest consideration for hard money lenders is the value of the property you’re using the funding to buy instead of your creditworthiness as a borrower.
How Does the Process Work?
A hard money lender might still go through a quick credit check, but it’s not as stringent as getting a traditional loan.
While it can sound great, especially for borrowers who wouldn’t otherwise be approved, there are downsides. The lender is taking on a lot more risk with this approach to lending, meaning the loan is likely to be more expensive for you.
The interest rates are high, and some lenders will require much larger than normal down payments.
These loans are also short-term in many cases. That means you could have just a few years to pay them back instead of a term of 15 or 30 years.
Who Uses These Loans?
Real estate investors are the primary market for hard money loans.
Investors who flip houses, for example, may use hard money funding. Flipping a house and reselling it usually can happen pretty quickly. When a flipper finds a good deal on a property, they want to act fast, so the quick funding of hard money is appealing. Flippers also usually sell the house fast, so they don’t need a long loan term anyway.
If someone wants to buy a rental property as an investment, the idea is similar.
If you’re a business owner who wants to buy commercial property, hard money funding can help you when you’re not able to get traditional financing.
Interest Rates on Hard Money Loans
The interest rates are going up on conventional 30-year fixed-rate mortgages. The average right now is nearly 6%.
Back in the fall of 2021, when interest rates were averaging 3%, hard money loans had interest rates of anywhere from 8-15%. Now, they’re significantly higher.
Hard money loans are expensive and risky. They’re best left to professional real estate investors as a result. They’re not an ideal option if a traditional lender can’t approve you. Instead, work to deal with the root causes of why you aren’t able to get a mortgage and try to fix those issues.