Advantages And Disadvantages Of Hard Money Loans
For many borrowers, the term hard money loan is likely to be met with derision and skepticism. Most individuals view this financing option as a last resort option offered by people of less than ideal reputation.
While there’s undoubtedly some merit to this notion, hard money loans do present their own set of advantages and disadvantages. Moreover, they fill a legitimate niche in the real estate market.
What Is A Hard Money Loan
This lending product is an asset-backed financing option in which the borrower uses real estate to secure the financing. It allows borrowers to bypass traditional lenders and lending criteria and deal directly with hard money lenders.
Traditional lenders require some form of guarantee that the borrower will be able to repay an arrear. In most cases, lenders determine an applicant’s ability to pay off debt based on his or her credit score and financial situation. In contrast, hard lenders take an entirely different approach. They aren’t so much concerned with an applicant's ability to repay but instead with the value of the asset used to secure the financing.
How Do Hard Money Loans Work?
As stated above, this lending product is simply a short-term loan that’s secured by the borrower's property. The type of property itself doesn’t matter, as long as it has an equal or greater worth than the financing amount.
The way these lending products work is similar to traditional secured debt. This is because the borrower pledges an asset to guarantee the financing. Should the borrower default, the lender has the legal right to repossess the property.
This option is typically sought out by people who have poor or no credit but require cash fast. Additionally, these lending products usually carry much shorter term lengths than traditional real-estate-based mortgages. Tenures typically range from one to five years.
It’s important to note that traditional banks and lenders don’t offer this type of financing. Thus, this lending product must be acquired through private lenders or individuals. Even though this option is generally considered high-risk, it may be appropriate for some people in specific situations.
Most Common Reasons To Take Out A Hard Money Loan
- Flipping house: Sometimes, developers or flippers will see a house on the market that they feel they can purchase, renovate, and flip for a good profit. Since these individuals may not want to engage in a 15 or 30-year mortgage, a hard money construction loan is much more ideal
- Property development: Similar to house flippers, some builders and developers will purchase a piece of property with this type of lending product, build on it, and sell the house. If they can do this within a short time frame, it’ll allow them to pay off the debt quickly, not incurring high-interest costs
- Low credit score: For others, these lending products may be a last resort if they require fast access to cash and fail to get approved through more traditional means
Advantages And Disadvantages Of A Hard Money Loan
- High approval rate: Since hard money lenders aren’t concerned with the borrower's creditworthiness, anyone who has sufficient assets to secure the loan can be approved
- Access to fast cash: Traditional mortgages or development lending products can take weeks or months to process. Applicants can be approved in as little as a few business days for hard money financing
- Extra flexibility: These loans aren’t subject to the same underwriting process that traditional mortgages are. Therefore, borrowers have much more power to negotiate adjustments and changes to the payback schedule
- High rates of interest: This lending product carries higher interest rates than a traditional mortgage or equity-based loan. The average hard loan carries a rate of between 7.5% and 18%, depending on the lender
- Low LTV ratio: Even the best hard money lenders will grant lending products totaling 50% to 70% of the property’s value. Regular mortgages usually cover at least 80% of the property’s value
Hard money loans are short-term, high-interest, high-risk lending products that are guaranteed by real-estate holdings. Should a borrower fail to pay back his or her debt, the lender will be able to take possession of the pledged property to cover the remaining balance.
This type of financing is traditionally seen as a last resort option for borrowers with low or no credit. However, some individuals, such as house flippers, use it to make a profit on developed properties.