You may have heard of hard money lending. However, most of the people who walk through my office don’t know why or how these loans are able to be secured and distributed so quickly.
This article will cover the details of why and how hard money loans work, with insights from a lender.
What Is a Hard Money Loan?
Hard money lending refers to short-term loans funded by private investors that are secured through real estate.
Unlike hard money, banks and credit unions that fund traditional (or “soft”) loans collect extensive information about the borrower to determine if they qualify. Such checks may include detailed credit history, credit score, criminal and personal background, and even rental history.
Banks require quantitative data that provides enough evidence to conclude that the likelihood of the loan being paid off is practically guaranteed. To gather such information can take days, weeks, or even months depending on the specifics of the loan.
Hard money loans, on the other hand, are relatively fast in comparison to a traditional loan. “How fast?” you might ask.
Compared to a public lender, where a loan request could take up to 90 days to complete, hard money lenders may be able to process a loan in as quickly as 48 hours. This allows for individuals to act on the best deals available as fast as possible.
Who Really Benefits From Hard Money Loans?
As you could have guessed, those with a less-than-perfect financial history commonly take advantage of hard money loans. Since banks will likely not approve a traditional loan request from someone with a bad credit score or a history of bankruptcy, private lenders are a better option.
We as hard lenders are less concerned about the details of the borrower, so those with dismal credit history need not fret—hard money loans are a practical option.
There may be a negative connotation associated with hard money loans because of our willingness to lend to those with poor financial history. However, there are other types of people who can benefit from soft loan alternatives, too.
Consider those who need money very quickly—like real estate investors trying to scoop up a hot deal. Because of its swift turnover time, hard money loans offer a solution.
Looking to buy a foreclosure or short sale? Investors can get their hands on the funds necessary to purchase in an exponentially faster amount of time than that of a traditional loan.
Hard money lenders are both personal and independent financial institutions, so those looking for a loan need only meet the individual lending company’s unique policies. Typically, these policies are much more lenient with minimal qualifications required for approval.
This is why hard money is attractive to anyone who may not want to divulge their personal financial history, as well as anyone who needs money fast.
How Do Lenders Decide Who to Approve for a Hard Money Loan?
Since hard money lenders are not concerned with the details of the borrower, what do they base their decision to lend on? The answer is simple: the value of the collateral.
Hard money lenders focus their concern on what is called the loan-to-value ratio, or LTV. The LTV is the loan amount divided by the value of the property.
While the LTV requirement is unique to each vendor, you can generally expect it to be around 60 to 70 percent.
This means, if someone is looking to take out a $100,000 loan, the property they plan to leverage with the lender needs to be valued somewhere between $140,000 to $160,000. That way, even if the borrower fails to pay anything back, the lender remains secure since the property is valued higher than the amount of money loaned.
The potential to gain or lose an asset with substantial equity is what both motivates the lender to supply the money and encourages the borrower to pay it back quickly.
The only caveat here is the property type. Even if the estate has an acceptable LTV, for many lenders, the type of real estate being used as collateral (i.e., schools, churches, car washes, gas stations, hotels, etc.), may not fit into their lending portfolio.
The lender has to protect itself. So, by only agreeing to lend to those assets that a lender feels comfortable with, the lender secures the ability to liquify the leveraged asset for cash without being limited by the property type.
Why Do Hard Money Loans Get a Bad Rap?
One of the disadvantages associated with hard money loans, and one of the main reasons people shy away from them, are heightened interest rates.
Because these loans are specifically suited for investments that will turn a profit quickly, interest rates can go as high as 18 percent. In contrast, traditional loan interest rates usually hover around 5 percent.
While this may seem like an exceptionally high rate, being able to finance large expenses quickly in order to secure an investment can mean thousands of dollars in potential profit for the borrower. That is, if they pay the agreed upon amount in the agreed upon time.
This means the borrower gets to make their investment, and the interest rate means profit for the lender. Win-win!
Many hard lending companies are known for their expediency, simplicity, and transparency. Do not let falsely perceived notions about hard money lending get in the way of making the investment of a lifetime!
Prospective investors looking to flip a house on foreclosure for big profits, those with a lackluster credit score, or anyone who simply doesn’t want to jump through the hoops of what is conventional banking can all reap the advantages of taking out a hard money loan if done correctly.
What other questions about hard money can I answer for you?
Ask me anything in the comment section below.