What Is a Hard Money Loan?

How Does a Hard Money Loan Work?

Hard money loans, also called equity-based loans, private money loans or bridge loans (when referring to hard money commercial property loans), work by using real estate that you own as collateral.

The lender extends financing primarily on the strength of your property’s value. The lender also may agree to consider other collateral, such as a second property or a financial account, if your property value isn’t high enough to secure the loan by itself.

Hard money borrowers are usually real-estate investors, though hard money business loans are sometimes taken out by small business owners who own property.

• Why Consider a Hard Money Loan?

  Borrowers typically take out hard money loans for a number of purposes:

  • You plan to fix and flip a property and need short-term financing until you can sell it.
  • You need a loan to buy land for investment or to complete a construction project.
  • You’re competing to buy a property against cash offers.
  • You can’t qualify for a conventional loan because of credit issues, but you have collateral.
  • You need financing faster than a conventional loan would take to process.

Hard money loans fall into the short-term loan category, often within 1 year.

Hard money financing differs from conventional forms of financing in terms of how your creditworthiness gets evaluated. Typically, creditworthiness depends on your ability to repay your loan as measured by your income or credit rating. But with a hard money loan, because your property secures your loan, lenders place less weight on your income and credit score. Your ability to get a hard money loan depends more on an appraisal of the value of your property than on your credit score.

If you fail to repay your loan, hard money lenders can sell your property to recover their capital. This makes hard money loans riskier to borrowers than other forms of financing.

Another way hard money lenders differ from conventional lenders: Most hard money loan financing comes from private lenders or groups of investors rather than banks or credit unions.

Hard Money Loan Rates

For lenders, hard money loans represent a higher risk than traditional loans. Accordingly, interest rates tend to run higher. For comparison, as of Dec. 5, 2019, rates for 30-year fixed-rate mortgages averaged 3.68%, according to Federal Reserve data. (3) In contrast, as of January 2019, hard money rates ranged from 7.5% to 15%, depending on the length of the loan, according to several financing-related websites, including Investopedia. As a general rule, a longer loan term means a higher interest rate, since it takes the lender longer to recover their money.

Additional Fees

In addition to high interest rates, hard money loans often carry additional fees. You may need to make a down payment as high as 20% or more, with rates higher when your loan is backed by an investment property and lower when backed by your primary residence.  You may be able to put down a lower down payment if you buy mortgage insurance, but this will raise the cost of your loan.

Balloon Payment

At the end of your hard money loan, you also may have to make a balloon payment, also known as a bullet payment. With this arrangement, your principal only gets partially repaid (amortized) over the term of your loan and you have to pay off the balance in a large final payment. For example, your final payment may be double the cost of your normal monthly payments.

Another fee your lender may require you to pay is an origination fee. This fee represents the cost of processing your loan. Because hard money loans represent a higher risk for lenders, they may involve a higher origination fee than other loans.

Other costs associated with hard money loans can include fees for:

• Property surveys
• Property appraisals
• Home inspections
• Title closing

These costs often get built into your loan cost rather than billed as separate fees.

Hard Money Loan Requirements

To qualify for a hard money loan, the loan value you request must not exceed a designated percentage of the value of the property you’re offering as collateral. Lenders want assurance that they can resell your property and recover their money quickly if a borrower defaults on a loan. The higher the amount of the loan in proportion to the value of the property, the higher the risk to the lender. Higher risk lowers your chances of getting the loan. It also raises your interest rates if you do qualify.

To evaluate loan risk, hard money lenders typically use one of two methods to assess how your loan amount compares with your property value:

• Loan-to-value (LTV) ratio
• After repair value (ARV)

Loan-to-Value Ratio

The LTV ratio compares the amount of your loan request to the current value of the property before any improvements. For instance, if you wanted a $100,000 loan on a property worth $120,000, your LTV ratio would be $100,000 ÷ $120,000, equivalent to about 83.33%.

To mitigate risk, lenders prefer to limit hard money loans to cases where the LTV is 50% to 70% or less, according to a number of finance-related sources.

After Repair Value

ARV uses a similar formula to LTV, but compares the amount of your loan request with the projected value of your property after you have made any renovations you intend to make. This represents a higher risk for the lender because they’re investing in financing your projected repairs, which you may or may not actually end up making. Because of this higher risk, hard money loans based on ARV ratios tend to carry higher interest rates. Lenders also will want to see a line-item budget on your repair plans and may conduct periodic inspections on the progress of your repairs.

To assess the value of your property, hard money lenders will typically commission a broker price opinion (BPO) or one or more property appraisals. A BPO is less comprehensive, making it quicker and less expensive, but it is less authoritative, so many lenders will prefer to use appraisers.

Assessing Your Property’s Value

The broker or appraiser will consider factors such as the value of similar properties in your area. Multiple independent appraisals may be commissioned to verify the value of your property. A survey and home inspection also may be required. The costs for these services usually get built into the cost of your loan.

Hard money lenders normally assume that the property you’re offering as collateral is an investment property, not your primary residence. If you’re offering your primary residence as collateral, you should discuss this with your lender. Lenders may or may not accept a primary residence as collateral. However, if they do, they may require a lower down payment, since you’re perceived as less likely to default on a loan if your own house is at risk.

How to Get a Hard Money Loan

To get a hard money loan, you normally need to be a property investor and the owner of an investment property other than your primary residence. The amount of your loan amount request shouldn’t exceed your prospective lender’s designated LTV or ARV ratio.

You may be able to improve your chances of getting a loan by first doing some research to estimate the value of your property and to find out what ratio your prospective lender uses.

You can estimate the value of your property by:

• Using an online tool such as Zillow’s Zestimate
• Comparing listings for other properties in your area
• Asking a real-estate agent for a comparative market analysis (CMA), which is less expensive than an appraisal and is often done free
• Getting a professional appraisal

If your property’s value is too low in proportion to your requested loan amount, some lenders may allow you to include additional forms of collateral. These can include a second property or a financial account.

Hard Money Loan With No Credit Check

Because a hard money loan gets covered with your property collateral, lenders don’t place an emphasis on your credit score. This makes hard money loans for bad credit borrowers an option.

Some lenders may not perform a credit check at all. However, if your lender does perform a credit check, having a good credit score may improve your odds of getting a loan or help you get a lower rate.

Weigh Hard Money Loans Against Other Options

Hard money loans can be a useful financing tool if you’re a real estate investor who needs to flip a property, or if you’re a small business owner who owns property and needs short-term financing.

However, hard money loans have high interest rates and they carry the risk of losing property, making it prudent to consider other financing options first. Fast Capital 360 offers a number of financing options for small businesses, including term loans, business lines of credit, accounts receivable financing and other solutions to fit any need.