An In-Depth Look at Hard Money Loans

What is a Hard Money Loan?

A hard money loan is a type of loan that real estate investors often use. It's considered a short-term loan, or a bridge loan, as they're typically granted for 12 months, but they can be extended to two to five years. The borrower receives funds based on the value of the property, not their credit score. That's why it's called "hard" money - it's less concerned with the individual borrowing, and more concerned with the hard asset they have as collateral.

How Hard Money Loans Work

Hard money loans are different from traditional bank loans. Here's a breakdown of the process:

1. 1. Loan Request: The borrower submits a loan request detailing the property, the plans for the property, an exit strategy and financial details about the borrower.
3. 2. Property Evaluation: The lender will assess the property, its location, its current and potential future value, the amount of work required, and the market conditions. In many cases, the loan amount is based on the After Repair Value (ARV), which is an estimate of the property value after it has been improved.
5. 3. Deal Assessment: If the lender decides to go forward after the property evaluation, they will assess the deal more closely. This may involve looking at the borrower's plan for the property, the timeline, and exit strategy.
7. 4. Loan Origination: If the lender approves the deal, they will issue the loan, typically charging points (a percentage of the loan amount) and interest. The terms can vary greatly from deal to deal, but interest rates can range from 10% to 15% and points from 2 to 5.
9. 5. Repayment: The borrower is responsible for making regular payments to pay off the loan, typically interest-only payments with a balloon payment at the end of the term. If the borrower fails to repay, the lender has the right to take the property and sell it to recoup their money.

Benefits of Hard Money Loans

The main advantages of hard money loans are speed and flexibility. Since hard money lenders focus on the property's value and its potential, instead of the borrower's credit, they can make decisions much faster than traditional banks. This can be crucial for real estate investors looking at competitive properties.

The terms of hard money loans can also be more flexible than traditional loans, often able to be customized to the individual project. This can include the repayment schedule, interest rates, and more.

Risks and Considerations

The major downside to hard money loans is the cost. They are significantly more expensive than traditional financing due to higher interest rates and fees. They are also short-term, so they require an exit strategy, whether its selling the property or refinancing with a traditional lender.

Hard money loans can be a powerful tool for real estate investors. They offer quick, flexible financing for investment properties but come with higher costs and risks. Like any financial decision, its important for borrowers to understand the terms and make sure it aligns with their investment strategy.