What Are Hard Money Loans?

Hard money loans are real estate investors' and developers' answers to quick and simple business deals that provide access to money when they need it most. However, that doesn't mean they're the best (or safest) option for everybody. 

Key Takeaways

• A hard money loan is secured by real property and is often considered difficult to acquire. It's thought of as a loan of "last resort," and is typically granted by companies or individuals, instead of banks.
• This type of loan has an average term of 12 months, but it can run between a few months and a few years — much shorter than conventional mortgages.
• Property flippers, developers, and other real estate investors tend to take out hard money loans.

What Is a Hard Money Loan?

Deemed a "last resort" loan or a short-term bridge loan, hard money loans are secured by real property (i.e., the property becomes the collateral). They are mainly utilized in real estate transactions, with the lenders being companies or individuals rather than banks or other institutions due to their riskier nature.

They are commonly used by house flippers, developers, and other investors, but could also be a solution for people facing foreclosure.

How Hard Money Loans Work

Unlike traditional loans, hard money loans are granted mainly based on the value of the property provided as collateral and not on your (i.e., the borrower's) creditworthiness.

While the lender might superficially check your finances or credit history, the process is much less rigorous than a regular loan, allowing you to receive money within days, not weeks or months.

Since there are inherent risks with this style of lending, you won't find hard money loans offered at regular banks or financial institutions. Instead, they are offered by private individuals or companies that realize the value in these potentially risk-filled endeavors. Depending on the provider, they may be structured as interest-only loans requiring a huge balloon payment at the end.

Hard money loans are underwritten differently and have distinct requirements over standard financing. He mentions that the value in hard money loan deals is factored into the underwriting more than the borrower's credit. Many will require larger down payments than conventional real estate loans. 

Not to mention that they often come with short repayment periods of a few years compared to the 15- to 30-year terms offered by traditional mortgages.

Here is an example of a hard money loan from application to payoff, see below:

Step	Description
1. Application	Real estate investor applies for a hard money loan from a private lender.
2. Property Valuation	John applies for a hard money loan from a private lender. He provides information about the property, his renovation plans, and his experience as a real estate investor.
3. Loan Approval	The lender evaluates the property to determine its current value and the After Repair Value (ARV) after renovations. The loan amount is typically based on a percentage of the ARV, often around 70-80%.
4. Loan Terms	John receives the loan, and the term is short, such as 12 months, but can be extended in some cases.
5. Renovation	John uses the loan to purchase the property and begins the renovation process. He completes the renovations within the agreed-upon timeframe.
6. Sale of Property	Once the renovations are complete, John lists the property for sale. He finds a buyer and sells the property for a profit.
7. Loan Repayment	John repays the hard money loan, including the principal amount, interest, and any fees.
8. Profit	After repaying the loan, John keeps the remaining profit from the sale of the property.

What Are Typical Terms for Hard Money Loans?

The terms for hard money loans can vary from just a few months to several years. However, they mostly sport terms around 12 months and may come with the ability to shorten or extend in certain scenarios. Although, this varies from provider to provider.

What Are the Risks of a Hard Money Loan?

Like most financial vehicles, hard money loans come with their fair share of risks. However, the biggest in this case is missing payments or failing to sell the property in time to cover the outstanding balance. Due to the higher upfront costs and shorter repayment terms, they can dig investors into a deep debt hole if used irresponsibly.

If you plan to take out this type of loan, make sure you have a foolproof plan to cover the cost if the market turns and real estate prices drop sharply.

Pros and Cons of Hard Money Loans

Understanding the pros and cons of hard money loans helps you make a well-informed decision.

Pros of Hard Money Loans

Hard money loans come with these positives:

• Rapid access to funds. The traditional mortgage underwriting process is notorious for moving at a glacial pace. Hard money loans, on the other hand, can be processed in mere days. For real estate investors, this speed can be the difference between successfully closing a deal and losing out, particularly during competitive property auctions.
• Deal validation. Hard money lenders are well-versed in determining whether rental property deals will turn into a money pit. After all, they fund many other investors. Therefore, if a handful of hard money lenders say no to your deal, you should be cautious; experienced investors can anticipate potential risks before greener industry participants.
• Incredibly flexible terms. While this isn't always the case, most hard money lenders are flexible when negotiating the terms. How do they achieve this flexibility? They don't need to adhere to the stringent regulations that govern the conventional mortgage realm.
• No credit history criteria. Gaining approval doesn't mean submitting a bunch of financial documentation or having a near-perfect credit score. Traditional mortgage underwriting is laser-focused on your income and credit history, but hard money loan lenders offer loans based on the building put forth as collateral. Therefore, they utilize the estimated market value of the property after planned repairs to decide whether to grant the loan.

Cons of Hard Money Loans

But, they also bring these negatives:

• Conservative LTV ratios. You need considerable assets to be approved for a hard money loan. Generally speaking, lenders necessitate a loan-to-value (LTV) ratio of 50% to 70% — much more conservative than traditional mortgages. For example, Fannie Mae guidelines note an LTV ratio that runs from 75% to 967%!
• Come with higher costs. Conventional loans don't come with costs as high as hard money loans. The upfront fees tend to be exorbitant, with many stretching three to five points higher. The same can be said for closing costs, alongside the significant down payment required to acquire the loan in the first place. On top of that, you could be subject to a prepayment penalty if you decide to repay the loan sooner than your term states, adding to the already-expensive costs.
• Subject to regulations. Despite the fact they aren't subject to the same regulations as conventional mortgages, hard money loan lenders must adhere to federal and state laws that prevent them from lending to people who can't repay it. As the law states, these lenders must establish you can meet the monthly payments plus any scheduled balloon payment before signing the loan off.
• Short terms. Most hard money loans do not have long-term periods. Whether it's six months or multiple years, you won't have long to comply with the agreement you signed in the beginning. For this reason, most property investors use them for brief periods while waiting for stable, affordable financing.

Examples of Hard Money Loans

Developers, real estate investors, and flippers typically take out hard money loans since they can be finalized much quicker than traditional bank loans — a matter of days, not weeks.

Here are a few justifiable reasons to take out a hard money loan:

Property Flippers

Property flippers renovate and resell houses to turn a profit within a year or sooner. They often seek hard money loans to finance their project, using the property itself as collateral for the loan. They offset the generally higher cost of these loans by repaying the loan relatively quickly (i.e., in a few months).

Wholesale Funding

Due to the speed at which hard money loans can be acquired, they're used for wholesale flips. It's beneficial because wholesale funding can be utilized instead of contract assignments, ensuring the buyer and seller do not know the financial spread. 

Renovate and Rent

Some people take out hard money loans for real estate projects that will be rented after. These acquisitions are funded in a similar way to property flippers but are typically refinanced for a longer term following the project's completion to ensure the best value.

Is a Hard Money Loan a Good Investment?

Whether or not a hard money loan is a good investment depends on what you're using the money for.

They make sense for wealthy investors who require fast funding for an investment property and want to bypass the red tape that surrounds traditional bank financing. In other words, they are useful for paying off one-time projects or expenses if you can afford to repay them.

Alternatives to Hard Money Loans

Hard money loans have undeniable uses, but they aren't perfect for every investor or every scenario. Sometimes, you'll need to find an alternative. The following are just some of the options at your disposal:

Home Equity Line of Credit (HELOC)

Otherwise known as a HELOC, a home equity line of credit is a well-known financing method to use when you have a real estate asset to borrow against. Put simply, this vehicle turns your house or other property into a line of credit — you borrow against the equity you've built up and repay it over time.

Home Equity Investment Products

A home equity investment product has an advantage over a home equity line of credit — you don't have the repay the loan immediately. You get the same access to the equity you've accrued in your home without monthly or interest payments. Plus, you can often access the money in just three weeks.

Related: Home equity loans vs HELOC

Cash-Out Refinance

This method requires an asset that you've built equity into. You refinance the property, taking some of the money from the property and investing it in your new project. 

Naturally, you must pay the money back plus interest. However, the major benefit of the cash-out refinance plan is that you borrow against your current equity, letting you access cash you've already paid.

Peer-to-Peer Loans

Peer-to-peer loans aren't legal in all states, but they can be a good form of last-minute financing. They are akin to crowdfunded loans wherein individual investors own small portions of the loans and get repaid as you pay the money back.

Like hard money loans, these aren't great options for everybody. They tend to be used by people who don't have other options or are just entering the real estate development sphere.

HomeStyle Loan

A HomeStyle loan is a government-backed mortgage that lets you renovate your house. It allows you to borrow the purchase price of the property plus renovation costs, wrapping it into one mortgage loan amount. 

Private Money Loans

Last but not least, you can reach out to your friends or family for a private money loan. While it can feel awkward, it's a good option for those with wealthy inner circles.