Brief Explanation: Hard Money Loans for Real Estate Investor

What is a hard money loan?

A hard currency loan is a type of loan that is secured by real property.  Hard money loans are considered "last resort" or short-term bridge loans.  These loans are mainly used in real estate transactions, the lenders are usually individuals or companies and not banks.

Hard Money Loans for Real Estate Investors
Hard Money Loans for Real Estate Investors

How a hard money loan works

The terms of a hard money loan are primarily based on the value of the asset being used as collateral and not on the borrower's credit.  Since traditional lenders, such as banks, do not make hard money loans, hard money lenders are often private individuals or companies that see value in an enterprise with this type of potential risk.

Hard money loans, sometimes referred to as bridge loans, are short-term lending tools that real estate investors can use to finance an investment project. This type of loan is often a tool for home flippers or real estate developers who aim to renovate or develop a property, then sell it for a profit. Hard money loans are issued by private lenders rather than mainstream financial institutions such as banks. 

Unlike traditional bank loans, the ability to obtain hard money financing is not determined by the creditworthiness of the borrower. Instead, hard money lenders use the value of the property to determine whether to take out a loan. Specifically, lenders focus on the "after repair price" or ARV, which is an estimate of what value the property will be after the renovation or development phase is completed.

Hard money loans can be sought by property flippers who plan to renovate and resell real estate that is used as collateral for financing - often within a year, if not sooner.  The high cost of a hard currency loan is offset by the fact that the borrower intends to pay off the loan relatively quickly - the hardest money loan is for one to three years - and some other benefits that they provide.

key takeaways:

(i) Hard money loans are mainly used for real estate transactions and are the money of an individual or a company and not a bank.

(ii) A hard currency loan, which is usually withdrawn for a short period of time, is a way to quickly raise money, but higher costs and lower LTV ratios.

(iii) Because the hard money loan depends on the collateral rather than the financial status of the applicant, the funding time frame is shorter.

(iv) The terms of a hard money loan can often be negotiated between the lender and the borrower.  These loans typically use assets as collateral.

(iv) Repayment may default and still be a profitable transaction for the lender.

Using Hard money loan for real estate investor

Investing in real estate can be an attractive opportunity for building wealth, and is an effective way to diversify your portfolio. Real estate investment trusts (REITs) and real estate crowdfunding allow you to invest passively, but some investors may prefer to own the property directly.

If you do not relax with a substantial amount of cash upfront to buy real estate, a hard money loan may be the answer. While this type of loan has advantages over traditional financing, it has a potential downfall. A fixed capital buffer is still required.

The cost of a hard currency loan for the borrower is generally higher than the financing available through banks or government lending programs, which reflects a higher risk by offering lender financing. However, increased expenditures are a trade-off for faster access to capital, less rigorous approval processes, and potential flexibility in repayment schedules.

Hard money loans can be used by borrowers with turnaround conditions, short-term financing, and poor loans but have sufficient equity in their assets. Since it can be issued quickly, a hard currency loan can be used as a way to close foreclosure.

Cons:

Hard money lending is not a complete financing solution. There are two primary drawbacks to consider:

Cost - Hard money loans are convenient, but investors pay a price for borrowing this way. This rate can be up to 10 percent higher than conventional loans. Origination fees, debt-servicing fees, and closing costs are also likely to cost investors more.

Short repayment period - The purpose of a hard currency loan is to allow an investor to get a property ready to go on the market as quickly as possible. As a result, these loans have much shorter repayment terms than traditional mortgage loans. When choosing a hard money lender, it is necessary to be clear how quickly the property will become profitable to ensure that you will be able to repay the loan on time.

Pros:

There are many good reasons to consider getting a hard money loan from a bank instead of a traditional mortgage. The main benefits of this lending option to investors are:

Convenience - Applying for a mortgage is time-consuming, especially thanks to new regulations on mortgage lending implemented as part of the Dodd-Frank Act. It can take months to close on a loan, which risks losing investors on a particular investment property. With a hard currency loan, it is possible to get money in just a few weeks. This is important if you are funding for a large-scale development project and cannot tolerate deviations from time to completion.

Flexible Terms - Because hard money loans are offered by private lenders, it is possible for investors to have more room for negotiating loan terms. You may be able to record a repayment schedule for your needs or receive some fees, such as basic fees, reduced or eliminated during the underwriting process.

Collateral - With a hard currency loan, the property usually serves as collateral for the loan. But again, lenders can give investors a little leeway here. For example, some lenders may allow you to secure a loan using personal property, such as a retirement account or a residential property near you.

Bottom-line

Hard money loans are a good option for wealthy investors who need to quickly obtain funds for an investment property, without any red tape that goes with the financing of the bank. When evaluating hard money lenders, pay full attention to fees, interest rates, and loan terms. If you pay too much for a hard currency loan or cut it too short in the repayment period, it can affect how profitable your real estate venture is in the long run.


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