A hard money loan is a short-term loan that is secured by a real estate asset. Properties receiving the hard money loan are considered collateral on the deal. Hard money loans or mortgages are primarily used to secure financing quickly or when a borrower has credit issues. Hard money loans can be used as financing for most property types including apartments, office buildings, industrial properties, retail centers, and others. Hard money loans are a form of non-conforming loan for commercial or investment property that does not come from a traditional mortgage lender. Hard money loans are called as such due to the “hard” or tangible asset that secures the loan.
The drawbacks of hard money loans include higher interest rates and associated fees - this is due to the heightened risk that the hard money lender is taking on by offering the loan. Hard money lenders are typically an individual or group, as opposed to a bank in other real estate transactions.
A hard money lender is the lender overseeing a hard money loan. Typically, this can be a private investor, a group of investors, or a licensed mortgage broker that is using their own capital. Hard money lenders often are focused on underwriting the asset as opposed to the credit history of the borrower. When reviewing a potential loan, hard money lenders will require a firm understanding of the business plan for the asset. Typically, hard money lenders can get you capital quickly as a financing partner if you are able to meet their terms.
Hard money loans require several criteria to be met;
1. The first is often a down payment ranging from 30-40% of commercial property’s value.
2. Exemplify a supply of cash reserves to cover insurance, taxes, loan payments, among other costs.
3. Borrowers must also be able to show overall financial strength for meeting payments and experience in real estate.
4. A hard money lender will require details of the strategy for the loan's usage, as well as of the project and the property. The assumptions exemplified by the borrower must be reasonable and must include how the borrower will repay the loan - i.e. a thoughtful exit strategy.
In terms of rates, the average interest rate charged on a hard money loan can range anywhere from the high single digits to the mid teens.
Hard money loans are generally simpler to acquire than traditional bank loans, especially for real estate investment properties. When borrowers are cash strapped, requiring another push of quick funding, hard money loans can be arranged within a narrow time frame to meet that need. With fast approvals available upon the submission of all required documents, hard money loans can be arranged in a week or less.
Furthermore, these loans have a flexible prepayment period, meaning that borrowers can arrange customized repayment plans depending on the project’s timeline and requirements.
Hard money loans oftentimes do not have repayment penalties, as opposed to a traditional bank loan. This means that if you repay the loan quicker than expected, you will not be forced to pay a fee.
Lastly, credit history is not as much of a considered factor when lenders assess the hard money borrower. With a traditional bank, borrowers must prove a good credit history in order to secure funding. For hard money lenders, the key components of arranging financing include the borrower’s equity and the value of the property. If this criteria is met, borrowers are likely to be approved for their loan.
A hard money lender is oftentimes more focused on the value of the borrower’s hard assets, as opposed to the creditworthiness of the borrower. As a result, borrowers can often secure a hard money loan by proving a high borrower’s equity and equally high value of the investment property.
As opposed to a traditional bank loan, significantly less paperwork is required for a hard money loan. Paperwork required will likely include a proof of income - how the borrower plans on making monthly payments, a repayment strategy, an analysis of the properties’ value, and all fundamentals of the deal overall. The borrower will also be required to cover a down payment - the difference between the purchase price and the loan balance.
Borrowers should look for flexibility in a hard money lender. Borrower’s should be cautious when reviewing the loan documents to ensure they are in accordance with the business plan of the asset. Borrower’s should look to hard money lenders when they need to lock in financing quickly or have a spotty credit history.
Borrowers who need to secure financing quickly or have a checkered credit history should consider hard money loans. Borrower’s should only look for a hard money loan if they have a concrete business plan with a plan to exit into lower cost financing. If a borrower was denied a traditional mortgage for their property they could look to a hard money lender as an alternative given the...
Borrowers will face higher interest rates when dealing with a hard money lender. Hard money lenders require higher origination and servicing fees. Given the lack of regulation in hard money lending, there is an increased risk that a lender will attempt to take over a property if a business plan fails. Hard money loans also often require large down payments.