Hard Money Loans: Everything You Need To Know
If you’re looking for extra cash to fund your next project or to navigate times of 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’re in need of funds quickly or if you do not qualify for other forms of financing. But what are these loans and how are they different from more traditional loan options? While Rocket Mortgage® does not offer hard money loans, keep reading to learn more about how a hard money loan could impact you!
What Is A Hard Money Loan?
A hard money loan is a unique type of loan in which funds are secured by real property instead of the borrower’s creditworthiness.
Similar to a short-term bridge loan, hard money loans are primarily used in real estate transactions when the lender is an individual or company, as banks do not offer them. These loans typically last 1 – 3 years and are commonly used as a way to quickly collect money.
For example, if you want to buy a new house but your current residence has not yet sold, a hard money loan could be a way to use your house as collateral and free up funds to buy your new place. Because the funds can be issued quickly, this is also an appealing option for homeowners at risk of foreclosure. Other common reasons for hard money loans include buying an investment property and flipping houses.
The biggest distinction between hard money loans and other types of loans, such as traditional mortgages, is 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, as their financial background is not a factor in qualifying them. 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 does not play a role in qualifying for a hard money loan, there are still several factors the lender must consider before approval, including your home equity, debt-to-income (DTI) ratio, and loan-to-value (LTV) ratio. Once approved, hard money loans can be issued very quickly.
However, there is a tradeoff for this faster turnaround time – specifically higher interest rates and origination fees. Overall, hard money loans are more expensive because of the higher risk the lender is taking by offering the loan.
Hard Money Loan Rates: How They’re Set
The approval process for any loan breaks down to this: the lender reviews all background information to determine if you can reasonably commit to making the necessary payments. In the case of a hard money loan, the lender is not digging into your financial background, so they are automatically taking a higher risk that you will default on the loan. Hard loan lenders take this risk because the home is listed as collateral, meaning they can resell the property themselves if the borrower cannot follow through on their loan repayment.
This higher risk is the primary reason for higher interest rates in hard money loans. In general, interest rates range from 2 – 10 percentage points higher than traditional mortgages. As of 2020, the average interest rate for hard money loans is 11.25%.
The Risks Of Hard Money Loans
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 all borrowers must consider before deciding what is right for them.
In addition to higher interest rates, hard money loans also have more upfront costs, such as higher origination fees and closing costs, and tend to require a larger down payment of 30% or more.
This means if your financial background and credit score will qualify you for other forms of financing, there may be a better option available that will cost you less money in the long run!
Alternatives To Hard Money Loans
Rocket Mortgage® does not offer hard money loans; however, there are several other forms of financing 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 for you, keep reading to learn more about other types of loan options!
FHA loans are insured by the Federal Housing Administration (FHA), which protects lenders against defaults on payments, making it easier for borrowers to qualify and allowing lenders to offer lower interest rates. This option is key for people who will not meet the credit criteria for traditional mortgages. Additionally, bankruptcies and other financial issues in your past will not prevent you from qualifying.
A VA loan is a more affordable loan option offered for qualified veterans, service members and spouses. These loans are backed by the Department of Veterans Affairs and offer a less strict 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 avoid a down payment!
Home Equity Loans
Home equity loans are secondary mortgage loans that allow you to utilize the equity in your home, which is then paid back to the lender through monthly payments alongside your traditional mortgage payment.
To qualify, the borrower must have enough equity in their 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 worth of home equity.
Home equity loans also offer lower, fixed interest rates that you will not find with personal loans, making this a very popular option for homeowners. Although accessing your equity can be helpful, it’s important to remember that this will add to your monthly debt, so we recommend reviewing your monthly budget and consulting your financial advisor before committing!
The Bottom Line
Hard money loans can be a great option if you do not qualify for traditional forms of financing or if you’re in need of fast funds., their higher upfront costs and interest fees mean paying more over the life cycle of the loan. Understanding the pros and cons of hard money loans, as well as similar alternatives, can help you find the right option for your needs.
To continue your financial education, check out our Learning Center!