Hard money loans are a type of short-term mortgage loan that’s secured by a property. They can also be referred to as bridge loans. You might consider a hard money loan if you’re interested in financing an investment property. Before you apply for one of these loans, it’s important to understand how they work. A financial advisor can help you think through your options when it comes to short-term borrowing.
What Are Hard Money Loans?
A hard money loan is a short-term mortgage loan offered through private lenders or individuals. These loans are non-conforming and secured by the property they’re used to purchase. If the borrower defaults on a hard money loan, the lender can assume ownership of the property used to secure it.
In many ways, this sounds like a traditional mortgage loan. If you get a home loan, the loan is secured by the home. And if you don’t pay, the lender can initiate foreclosure proceedings against you. But there are some key differences, in terms of who offers these loans, what’s needed to get approved, repayment terms and what they’re used for.
How Do Hard Money Loans Work?
Hard money loans work by allowing borrowers to get a short-term loan based on the value of the underlying property that’s being used as security. Loan terms typically range from 12 to 36 months. Depending on how the loan is structured, you may only be required to pay interest during that time with one large balloon payment to make at the end of the loan term.
On the lender side, hard money loans are riskier since they have a shorter repayment window. This is why the lender can take ownership of the property used as security if you default. But that also means that you might pay may more in interest for a hard money loan than you would a traditional mortgage. It’s not uncommon to have a double-digit rate for this type of loan.
In terms of how to qualify for a hard money loan, the lender might look at your credit scores and income. But they may pay closer attention to your track record with real estate investing and the value of the property you want to buy. While some hard money lenders may offer loans to beginning investors, others may want to see that you have some experience with fix and flips or owning rental properties before handing over any money.
You may also need to bring a larger down payment to the table when applying for a hard money loan, depending on what the property is worth. This is because the lender wants to see that you have some skin in the game. So you might need 20% or even 30% down to get approved.
Pros and Cons of Hard Money Loans
Hard money loans can make buying an investment property easier but there are some potential downsides to keep in mind.
The pros of hard money loans include:
- Faster loan approval and funding times
- Credit history is less important for approval
- May be easier to get than traditional loans for purchasing investment properties
- Interest-only payments may be all that’s required on the loan
Now, here are some of the cons of hard money loans:
- Interest rates can be much higher than traditional mortgages
- You may need a larger down payment to qualify
- Balloon payments can be financially burdensome
- Beginning investors may have a harder time getting approved
Potential Burden of Servicing the Loan
One of the biggest cons is the potential to be stuck with a large loan payment. Again, say you’re getting a $250,000 loan to purchase a fix-and-flip property. You plan to invest $100,000 in the property in anticipation of being able to sell it or $500,000. Now, say the housing market tanks and the supply of buyers for your fix and flip dries up. At this point, you have a few options. You could drop your listing price to try to get a buyer to pay off the loan. This could mean reducing your profit margin or eliminating it altogether. You could default on the loan and let the lender have the property. This means you’re out the $100,000 you invested and your credit score will likely suffer.
The third option is refinancing your hard money loan into a conventional mortgage. You might consider that possibility if you want to avoid default because you don’t have money for the balloon payment. You could then rent out the property in the meantime. Of course, that entails its own costs as you’d have to pay closing fees on the loan. And you also have to be fairly certain you’ll be approved.
Long story short, hard money loans can be a risky venture. So it’s important to compare loan options along with the pros and cons to make sure it’s a good fit.
Who Needs a Hard Money Loan?
Hard money loans aren’t suited for the typical homebuyer. Typically, you might consider a hard money loan if you:
- Need money to buy an investment property
- Have been denied traditional mortgage financing
- Want a faster approval and closing time
- Have sufficient cash to make a larger down payment
- Meet a hard money lender’s qualification requirements
In terms of loan repayment, ask yourself how you’ll handle that. For example, will you be able to sell a fix and flip property before the loan term ends? Or if you’re buying what’s going to be a long-term rental investment property, will you refinance the hard money loan into a long-term mortgage? Having an exit plan in place before you take out a hard money loan can help you avoid any major financial snags once that loan comes due.
The Bottom Line
Hard money loans can be a financing solution for real estate investors, but they do come with some caveats. Weighing all of your options for purchasing a rental property can help you to decide if a hard money loan makes sense.
Mortgage Planning Tips
- Consider talking to a financial advisor about hard money loans and how they work for purchasing investment properties. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use SmartAsset’s mortgage comparison tool to compare mortgage rates from top lenders and find the one that best suits your needs.
- Enter the relevant data in SmartAsset’s no-cost mortgage calculator to get a quick estimate of what your monthly mortgage payment with taxes, fees and insurance will be.
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