Hard Money Loans: Everything You Need To Know
If you’re looking for extra cash to fund your next home flipping project, invest in a real estate property or navigate a financial hardship, taking out a loan could be a good option. But with so many loan options available, finding the right one for your needs can be challenging.
Hard money loans can be particularly beneficial if you need funds quickly or don’t qualify for other types of financing. But what are these loans, and how are they different from traditional loan options? Keep reading as we explain what a hard money loan is, how it works, how hard money lenders are different and explore the right type of loans for your needs.
What Is A Hard Money Loan?
A hard money loan is secured by real property – owned assets like land or buildings – but qualifying for the loan isn’t based on a borrower’s creditworthiness. They are non-conforming loans that are not offered by banks or mortgage lenders, but by private investors or companies.
One of the biggest distinctions between hard money loans and other types of loans, such as traditional mortgages, is that your house secures this loan. This means borrowers with a less solid credit history will have an easier time being approved for hard money loans because their financial background doesn’t play a role in qualifying them for hard money loans. Fewer qualification requirements also mean the approval process can be much faster – getting you the money you need when you need it.
How Does A Hard Money Loan Work?
So how does it work? Although your creditworthiness doesn’t play a role in qualifying you for a hard money loan, there are still several factors a lender must consider before approving you, including your home equity, debt-to-income ratio (DTI) and loan-to-value ratio (LTV). Once approved, hard money loans can be issued very quickly.
However, there is a trade-off for this faster turnaround time: higher interest rates and origination fees. Overall, hard money loans are more expensive because of the higher risk the lender is taking on the loan.
Common Uses For Hard Money Loans
Hard money loans have advantages that make them desirable for certain uses and certain kinds of borrowers. Let’s take a look at the types of borrowers who take out hard money loans and the common reasons why.
Hard money loans can be ideal for house flipping because flippers typically need cash fast. And if all goes well, you don’t need a long repayment period. A traditional 30-year mortgage doesn’t make sense to finance a property you plan to sell within 1 – 2 years.
Real Estate Investors
When an investment property that’s too good to pass up comes your way, a hard money loan can be a fast, practical option. Since hard money lenders are often investors, they’re also likely to approve these kinds of loans.
Financing For Borrowers With Credit Issues
Since hard money loans have less stringent requirements, they’re often easier to obtain for borrowers with less-than-stellar credit, a bankruptcy on their record or other negative items on their credit report. Hard money loans are also sometimes used by homeowners trying to prevent foreclosure.
Alternative To Bridge Loans
Some lenders offer bridge loans to serve as a cushion for those who are buying and selling a home simultaneously. However, if you don’t qualify for a bridge loan, a hard money loan can be a way to use your home as collateral and free up funds to buy your new place. The hard money loan’s short approval time and short term can make it a viable alternative.
Rocket Mortgage doesn’t offer bridge loans at this time.
What You Need To Know About Hard Money Lenders
Hard money lenders are often private real estate investors or real estate investment companies.
It’s important to thoroughly vet a hard money lender and have a real estate attorney look over the loan’s terms before taking out a loan. While there are plenty of reputable hard money lenders, there are predatory hard money lenders out there, too. So it’s important to research your options.
Hard money lenders can take on more risk since there is a higher return on investment and a quick turnaround time. Hard money loan terms are usually short, typically lasting 1 – 3 years. This fast turnaround means lenders will profit quickly – either from interest on the loan or if you default on the loan.
Let’s take a look at how higher interest rates come into play with hard money loans.
Hard Money Loan Rates: How They’re Set
During the approval process for any loan, a lender reviews all your background information to determine whether you can reasonably afford all the necessary payments. In the case of a hard money loan, the lender isn’t digging into your financial background, so there is a higher risk that you may default on the loan.
Hard money lenders take this risk because the home serves as the collateral that secures the loan. If the borrower defaults on the loan, they can resell the property to recoup their losses.
The higher risk associated with the loan is the primary reason for the loan’s higher interest rates. As of 2023, the interest rates for hard money loans are often 8% – 15%. While the interest rates are higher than many traditional loans, the trade-off can be worthwhile if you need fast approval.
Know The Risks: Is A Hard Money Loan Right For You?
Hard money loans are often considered loans of last resort for a reason. Despite plenty of upsides, like easier approval and faster funding, these loans also present certain risks that borrowers must consider before deciding what’s right for them.
In addition to higher interest rates, hard money loans also have higher upfront costs, such as origination fees and closing costs, and tend to require large down payments of 30% or more.
If your finances and credit score qualify you for other forms of financing, there may be a better loan option available that will cost you less money in the long run!
Alternatives To Hard Money Loans
There are other financing options you can consider. These options may have a stricter approval process, but they often come with lower upfront costs and interest rates.
If hard money loans aren’t the right fit, keep reading to learn more about other loan options!
FHA loans are insured by the Federal Housing Administration and typically have lower interest rates. Because FHA loans have more flexible loan requirements and are backed by the federal government, lenders can offer these loans to borrowers who may have struggled to meet conventional loan requirements. An FHA loan is a good option for borrowers who can’t meet the credit criteria for conventional mortgages or have bankruptcies or other past financial issues that prevent them from qualifying.
A VA loan is a more affordable loan option offered to qualified veterans, service members and surviving spouses. VA loans are backed by the Department of Veterans Affairs and offer a less stringent approval process and less expensive upfront costs.
When compared to conventional loans, the credit score requirements for VA loans are significantly lower, and you can qualify with more debt. If you qualify, you may even be able to get a loan with no down payment requirement.
Home Equity Loans
Home equity loans are secondary mortgage loans that allow you to borrow money from the equity in your home. You’ll make monthly payments to your lender until the loan is paid off. And you’ll make your home equity loan payments alongside your traditional mortgage payments.
To qualify, you must have enough equity in your home. Equity is the difference between what your home is worth and what you owe on your mortgage. For example, if you owe $250,000 on your mortgage and your home’s current value is $300,000, you have $50,000 in home equity.
Unlike personal loans, home equity loans also offer lower, fixed interest rates, making them a popular option for homeowners. Although accessing your home equity can be helpful, remember that this will add to your monthly debt. We strongly recommend reviewing your monthly budget and consulting your financial advisor before committing to a home equity loan.
The Bottom Line
Hard money loans can be a great option if you don’t qualify for traditional forms of financing or if you need fast funds. Unfortunately, their expensive upfront costs and interest fees mean paying more over the life of the loan. Understanding the pros and cons of hard money loans, as well as financing alternatives, can help you find the right option for your needs.