Shakespeare’s Polonius may have advised “neither a borrow nor a lender be,” but in our modern capitalist society, loans are an essential and reasonable tool for consumers, entrepreneurs, home buyers, and students alike. Different types of loans exist to supply the financial needs of people in varying circumstances, from conventional and open-ended loans to non-conforming and closed-ended loans. But what is a “hard money loan,” and when might you need one?
A hard money loan is sometimes referred to as a “private money loan,” which may sound ominous, but it really just means a short-term loan that is backed (secured) by real estate and funded through private investors or a fund of private investors. This is in contrast to conventional loans, which are typically supplied to borrowers by credit unions and banks.
Who Might Need a Hard Money Loan?
People who have difficulty obtaining conventional financing may find that a hard money loan is right for them. It may be difficult for some borrowers to get a conventional loan because they’ve experienced a short sale or a foreclosure. Despite these unfortunate circumstances, you can still get a hard money loan if you have sufficient equity in your property.
Hard money loans are frequently used by investors who need to act rapidly, such as a real estate investor who is attempting to purchase a property that has lots of other bids on it. Such loans are also used by borrowers who have credit issues, by people who are planning to fix up and flip a property, and for construction loans and land loans.
What Are the Terms of a Hard Money Loan?
The terms of a hard money loan will vary according to the lender, but typically the loan will need to be paid off in about year. Some such loans last longer, but it would be unusual for a hard money loan to extend beyond a five-year period. Payments have to be made monthly. These payments may consist of only interest and end with a balloon payment (i.e. repayment of the outstanding principal sum), or they may include both interest and some portion of the principal of the loan. (The principal is the original amount you borrowed.)
The terms of your loan will spell out the interest rate and points that the lender charges. This will depend on the region in which you live and the amount of competition among hard money lenders in your area. The more competition, the lower your interest rates and points will be. Because this sort of loan is riskier than a conventional loan, the interest rates do tend to be higher, and they can range up to as much as 15%. Points can rise as high as 4% of the total amount that you borrow.
How Much Money Can I Borrow?
The answer to that question will depend on the value of the property you are using to secure your hard money loan. Your personal credit and finances is not as important to the lender as the value of the property itself.
The lender will use a loan to value (LTV) ratio to determine how much money he can extend you. The LTV is the amount of the loan divided by the appraised value of the property that you are using for collateral. A lender may be willing to lend as much as three-fourths of the value of your property, but most will lend less.
What Kind of Property Can I Use to Secure My Loan?
You can use a property you already own or one that you are in the process of acquiring. Examples of properties that can be used to secure a hard money loan include the following:
• single-family residential homes
• multi-family residential homes
• industrial property
• commercial property
You may also be able to use an owner-occupied residential property, but a lot of lenders avoid these because of the difficult federal regulations involved. Not all lenders specialize in all types of property, so be sure to check your potential lender to learn what property you can use to secure your loan.
How Long Does It Take to Fund a Hard Money Loan?
One reason investors who need to move fast use hard money loans is that they can be funded much more quickly than conventional loans. Usually, it takes less than a week to fund a hard money loan. Sometimes, it only takes a day or a matter of hours. This is compared to the month or more that a typical bank loan requires.
Now that you know what a hard money loan is and how it works, you can begin your search for lenders.