Hard Money Loans: What Are They and How Do They Work?

Are you a business owner or real estate investor seeking easy, flexible financing? You may opt for a hard money loan.

Hard money loans are popular in real estate investing, especially for property flippers or individuals handling short-term projects. Consider them an alternative to traditional loans that do not focus on your creditworthiness or financial history and instead look into the value of the property you’re borrowing against.

Here is an introductory guide explaining hard money loans, how they work, and who they are suitable for.

What is a Hard Money Loan?

Hard money loans are a short-term, asset-backed financing option in real estate transactions. They are based on the property’s (being renovated or purchased) value, unlike traditional loans, which rely on the borrower’s credit score and financial history. While it benefits the borrower with an easy process, the asset is collateral in a hard money loan, which provides more security to the lender than a traditional loan, making it a balance of advantages for both the borrower and the lender.

Hard money loan lenders are, generally, private investors or companies, not conventional banks. They streamline approval and funding processes, so these loans are perfect for real estate investors looking for fast cash access and not waiting for weeks or months for loan approval.

Key Takeaways

1. They are a short-term loan type spanning 6 to 36 months
2. They are collateral-based, backed by the asset renovated or purchased
3. Private lenders, companies, and individuals are usually hard money loan lenders
4. Their interest rate is higher than traditional loans to counterbalance the lender’s risk

How Do Hard Money Loans Work?

A hard money loan differs from conventional financing, typically surrounding the property’s value rather than being fixated on the borrower’s financial profile. Here is a look at how it works.

Property Valuation

The property you are borrowing against requires evaluation to initiate the process. The lender determines the property’s potential value, especially after renovations (after-repair value/ARV), and offers a loan amount depending on a percentage of the asset’s ARV, called a loan-to-value (LTV) ratio.

LTVs for hard money loans are usually between 60% and 70%. So, if your property’s ARV is $500,000, a lender might offer $300,000 or $350,000.

Approval

After the property’s evaluation, the loan is approved based on its value rather than your credit score, facilitating faster approval than a conventional one. Expect approval within a few days.

Down Payment and LTV Ratio

One drawback of hard money loans is that they usually have a higher down payment than conventional loans. It helps reduce risk for lenders.

A borrower must have 20% to 30% of the property’s purchase or after-repair value, ensuring the lender has a financial buffer if necessary. For instance, if the property value is $500,000, you may have to put down $100,000 or $150,000.

Also Read: What Is an FHA Commercial Loan?

Repayment Terms and Monthly Payments

Hard money loans typically need a high down payment, ranging from 6 to 36 months. Many lenders offer interest-only payments, which means your monthly payments will only cover the loan interest. The end of the term requires the borrower to pay a balloon payment, covering the full principal loan amount.

If you are an investor and want to sell or refinance the property before the end of the loan term, it can be of huge advantage to you. However,  failing to sell or refinance the property can result in a financial situation, as you would be expected to make the balloon payment when the term ends.

Who are Hard Money Loans For?

They are perfect for real estate investors or business owners who need cash fast and are willing to accept higher costs and risks. Here are circumstances where a hard money loan could be beneficial:

• Flipping a Property: Flippers (real estate investors who buy homes to renovate and resell) generally use hard money loans the most. They need quick access to funds to acquire and improve properties before making a profit by selling them. Since these loans are short-term and involve fast approval, they are perfect for flippers.
• Buying a Foreclosure: Foreclosure properties usually require quick purchases at auctions. Since conventional loans are long-term and approval takes longer, hard money loans become a viable solution for fast cash.
• Bridge Loans: A hard money loan enables you to buy or renovate a property while waiting for your permanent financing to be ensured. It acts as a bridge between long-term financing attempts and immediate funds.
• Borrowers with Bad Credits: If your credit score is poor or you don’t have a robust financial history, hard money loans can be of great help because they focus on the property value over everything.

Conclusion

Hard money loans draw in a specific group of people seeking loans—those looking for fast cash access and are ready to face the higher costs and risks. For real estate investors, house flippers, business owners, and borrowers with poor credit, this type of loan is ideal. If you’re in a hurry and want a hard money loan from a reputable lender offering competitive interest rates and a better overall offer, call ALT Financial without hesitation.