Hard Money Loan

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Last Updated:June 5, 2024

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What Is a Hard Money Loan?

Hard money loans are short-term loans secured by real properties. Traditional banks don’t usually make these loans. Instead, they are made by certain private companies.

Also called short-term bridge loans, these loans are usually used as a desperate remedy wherein no other option may be available.

The main feature of such loans is that, instead of relying on financial strength or the loan applicant's credit score, they are backed by property or hard money, tangible assets like a particular property instead of paper money.

In default, the lender could take ownership of these tangible assets. Such loans are also often less stringent and can be approved quickly.

Thus, they are also helpful if time is of the essence and the loan is required urgently. However, they may have a higher cost in the form of higher interest rates.

This is because lenders face a higher degree of risk due to the less stringent process and the shorter loan duration, mainly 1 to 5 years. Thus, these loans may also have lower LTV ratios (Loan-to-value ratio).

Key Takeaways

A hard money loan is a type of loan secured by real estate property. It is typically issued by private lenders or investors and is characterized by higher interest rates and shorter repayment periods compared to traditional loans.
Hard money loans are primarily based on the value of the property being used as collateral rather than the borrower’s creditworthiness.
Hard money loans usually come with higher interest rates, often ranging from 8% to 15%, due to the increased risk taken on by the lender.
These loans are mainly used when funds are required urgently. They are given without the time-consuming process of judging an individual's creditworthiness, making them faster.

Understanding Hard Money Loan

To understand what these loans are, we first must understand the concept of Hard money. Hard money refers to physical assets like property. Therefore, these loans are backed by real investments as collateral.

In a traditional loan process, the borrower applies for a loan, and the lender checks their creditworthiness and whether the borrower is financially capable of repaying it. After that, the lender approves the loan.

This process is often lengthy due to the thorough study of the borrower's financials to minimize the risk for the lender. However, due to the protracted process and minimal risk, these loans may have lower interest rates.

On the other hand, hard money loans are based on the value of the property used as collateral. As these loans do not involve the lengthy process of checking creditworthiness, they are quicker and easier to get; however, due to increased risk, they may be more expensive too.

For example, the average interest on such loans was 11.25% in 2020. However, due to the high interest rates, they are usually repaid very quickly, mainly within 1-3 years.

Hard money loan rates

It has been stated multiple times that one of the significant drawbacks of hard money loans is that they can be costly compared to traditional loans due to the high interest rates and the low Loan-to-Value ratios.

According to Freddie Mac (the federal home loan mortgage corporation), the average interest rate for conventional loans like a 30-year fixed rate mortgage in May 2022 was only 5.09%. This interest rate skyrockets to somewhere from 8-13% when it comes to hard money loans.

Thus such loans are almost twice as costly when we compare them via interest rates.

Similarly, the LTV ratio on an average loan is usually around 70-80%, while in the case of these loans, it dips to 50-65%. If it means that these loans only provide loans to 50% of the value of the property, it will result in a requirement for a substantial down payment for the remaining value.

If an individual doesn’t have enough cash, hard money loans will not be able to finance their needs as they will not be able to find the financing to afford the huge percentage of the house the loan doesn’t cover.

How to get a hard money loan

These loans are usually not provided by regular financial institutions like banks. Instead, an individual would normally have to seek loans from private lenders. These lenders then give loans based on the property value used as collateral.

Additionally, such loans are usually disbursed very quickly, often within a few days or a couple of weeks, instead of the extenuating process that a traditional loan process has. However, this also translates to worse terms like a more significant down payment and high interest.

To look for hard money loans, especially for property, local real estate agents and real estate groups are often good sources for contacts.

However, due to the unregulated nature of such loans, it is often advisable for an individual to carefully examine the loan terms and approach many lenders to look for the best terms possible.

The borrower should also be careful because such lenders aren’t subject to the same rules and regulations as traditional banks and can potentially make their own rules regarding the details they need from the borrowers.

This can lead to predatory lending, as lenders may give very high-risk loans to clients who do not know what they signed up for. Thus, lenders must make all such loans very carefully.

Uses Of Hard Money Loan

Hard money loans are often only appropriate as a final resort if no other means of traditional loans are possible. These loans are also used when the need for funds is urgent, i.e., when the parties can’t wait long to get the funds.

For example, these loans may be beneficial for property flippers who plan to renovate a house and then flip it at a profit. The loan can be based on the property's value and paid back as soon as the renovation is complete, often within a year.

The high cost in such cases can be covered by the increased profits from flipping the house. In addition, the interest is offset by the fact that the loan is repaid quickly.

The acronym 'BRRRR' is often used, which stands for “buy, renovate, rent, refinance and repeat.” If a house flipper doesn’t want to wait for a long time, they take a short-term loan to finance their project, repay it as soon as it is completed, and repeat it.

Pros and Cons Of Hard Money Loan

The significant advantage of such loans is that they are a much faster option as they can be dispersed quickly. However, the faster disbursement also raises risks for the lender, resulting in higher interest rates and LTV ratios, making them rather costly.

Pros and Cons Of Hard Money Loan
Pros	Cons
Such loans are much quicker than traditional loans as they are based simply on the value of the collateral rather than the cumbersome process of judging an applicant's financial position.	These loans have a much lower Loan-To-Value ratio, which means an individual can borrow up to only 50%- 75% of the value of the collateral instead of around 80% in the case of traditional loans.
In the case of an existing relationship between the lender and the borrower, successive loans become even easier and quicker.	The interest rates tend to be extremely high, making these loans more expensive.
The lenders may not be as persistent with repayment as they may see default as more profitable due to more valuable collateral.	A hard loan lender may decide against funding an owner-occupied home due to compliance requirements and regulatory scrutiny.
These loans are more flexible as they are with a private lender rather than a bank. Small details like the repayment schedule may be easier to tweak.	These loans also have a higher degree of risk as if one cannot make enough revenue, they may be unable to pay back the loans due to the short time frames.

Are Hard Money Loans worth it?

A hard money loan can assist with short-term capital needs and be a great source of financing for such investments. However, it can come with its fair share of drawbacks. The high interest due to the added risk makes this loan quite costly.

Additionally, these have concise terms, so if things don't go one’s way, repayment can be very tough.

For example, if a loan is taken to renovate a house, but specific structural damage is caused to the house after it, which prevents it from being sold, the individual may face significant cash flow issues and may be unable to pay back the loan.

The LTV ratio or Loan Value ratio is often meager too. This means the ratio of the loan disbursed to the value of the collator. For example, if a house is worth $100,000, which is used as collateral, and the LTV ratio is 90%, the loan disbursed will be $90,000.

The ratio is often as low as 50-60% in the case of such loans. This means the loan is worth a lot less than the collateral, and if the borrower can’t pay it back, they can incur huge losses.

On the other hand, the lender can get huge profits by selling the property in case of default.