Hard Money Loan: Definition And What To Watch Out For

If the phrase “hard money loan” makes you think of quick and easy business deals that end with cold, hard cash, you’re not too far off the mark. However, just because a hard money loan offers fast financing doesn’t mean it’s a good, safe option for everyone.

So, what are hard money loans, and should you be wary of them? Let’s examine what you should look out for and consider the pros and cons of hard money loans

What Is A Hard Money Loan?

A hard money loan is a short-term loan that often requires the borrower to use an asset, like a home, as collateral to secure the loan. Hard money loans are also referred to as bridge loans and can be used to help finance one house while preparing to sell another.

Traditional lenders don’t issue hard money loans. You get them from individual investors or private companies. Borrowers may turn to hard money loans after a loan or mortgage application is denied or to avoid the lengthy process of getting approved for a loan through traditional methods.

Like a traditional or secured mortgage, a hard money loan is a secured loan guaranteed by the property it’s being used to purchase. The “hard” part of “hard money” refers to the tangible asset that backs the value of the loan. When a borrower defaults on a secured loan, a lender can take ownership of the asset to recoup losses.

Unlike traditional mortgages or other types of secured loans, the approval process for hard money loans is typically fast and less stringent, making them ideal if a purchase needs to happen quickly.

From application to close, applying for a mortgage can take more than a month. With hard money loans, you may close in just a few days.

How Do Hard Money Loans Work?

Let’s take a look at how hard money loans work compared to more traditional forms of financing.

Traditional Loan

To compare their differences, we’ll review how traditional loans work. While it’s not a formally defined category, “traditional” in this context refers to loans taken out through a familiar process: You apply for a loan, the lender checks your credit and ensures you can repay the loan, and – if the lender determines your finances meet their standards – you’re approved for the loan.

Traditional lenders will dive deeply into your entire financial situation, including your income, the amount of debt you owe other lenders, your credit history, your other assets (including cash reserves) and the size of your down payment.

Traditional lenders go through this sometimes-lengthy process to minimize their risk when they lend money. Lenders can offer better rates and more affordable financing by ensuring borrowers are creditworthy.

There are many traditional loans to explore, so don’t give up hope even if you imagine you may not meet their requirements.

How To Get A Hard Money Loan

With hard money loans, a lender approves a borrower based on the value of the property being purchased.

The lender may superficially check your credit or finances, but, in general, the process will be much less rigorous than with a traditional loan. The less stringent credit check allows borrowers to get their money in days instead of weeks or months.

The downside of this process is that because the lender takes on significantly more risk, that translates into a more expensive loan for the borrower. Hard money loans typically have high interest rates, and lenders may require larger-than-average down payments (though this isn’t always the case).

Hard money loans also tend to have short repayment periods – typically just a few years. Compare this to traditional mortgages that usually have 15-year or 30-year terms.

What Are Hard Money Loans Used For?

Here are some common reasons borrowers seek hard money loans instead of traditional loans.

Flipping A House

Real estate investors who buy fixer-upper homes to flip for profit may use hard money loans to finance their investments.

Because these projects typically move quickly, professional flippers often prefer faster financing. And because house flippers generally try to sell homes in a short period of time – typically less than a year – they don’t need a lengthy loan term.

Purchasing Investment Property

Borrowers who want to invest in rental property but don’t qualify for traditional financing might seek a hard money loan to pay for their investment.

A hard money loan can be useful if you can’t get approved for a traditional loan because of your credit history or need more money than a traditional lender will let you borrow.

Purchasing Commercial Property

A business owner may use a hard money loan to fund the purchase of commercial real estate. Hard money loans can be useful for entrepreneurs who don’t qualify for conventional financing to purchase unique property. The same may be true for borrowers who find traditional commercial loan limits too low for their needs.

Hard Money Lenders: What To Know About Working With Them

Hard money lenders are generally private investors or companies that deal specifically with this type of lending. Hard money lenders aren’t subject to the same regulations as traditional, conforming loan lenders. As a result, hard money lenders are more or less free to make their own rules about the credit scores or debt-to-income ratios (DTIs) they require from borrowers.

You can likely find a hard money lender to give you a loan even if you’ve been denied by traditional lenders. Hard money lenders focus more on the value of a property and less on a borrower’s creditworthiness.

Hard Money Loan Rates: What To Expect

Hard money loans are expensive. Just how expensive? Let’s compare hard money loan interest rates to traditional loan rates.

In August 2023, the average rate on a conventional 30-year fixed-rate mortgage was 7.09%, according to Freddie Mac. Hard money loans have much higher interest rates, typically around 8% – 15%.

Hard money loans can also be more expensive depending on the lender’s preferred loan-to-value ratio (LTV). If a lender will only finance 70% – 80% (or less) of a property’s value, you’ll likely need to bring a sizable down payment to the closing table. If you don’t have the cash, you may have a tough time finding a hard money lender to work with you.

The Pros And Cons Of Hard Money Loans

If you’re thinking about getting a hard money loan, make sure you understand the advantages and disadvantages of this type of loan.

Hard Money Loan Pros

As mentioned, the pros of using a hard money loan include:

• Faster approval process
• Approval based on property, not credit history
• Flexible loan terms
• Less strict underwriting
• Fix-and-flip properties quickly

Hard Money Loan Cons

The drawbacks of hard money loans include:

• High interest rates
• Typically large down payments, upfront fees and closing costs
• Less time to repay because of shorter terms
• Riskier than traditional financing
• Can carry a prepayment penalty

Alternatives To Hard Money Loans

If you’re not interested in a hard money loan, consider these alternatives:

• Private money loan: You can reach out to family, friends or others for a private money loan. Although it may feel a bit uncomfortable, it can be an option.
• Home equity line of credit (HELOC): A HELOC is useful when you want to embark on a home improvement project to increase the value of your home. However, with this alternative, a lien is placed on a home you already own – typically a primary residence – this can add risk if the purpose is to invest in real estate rather than upgrade the current home.
• HomeStyle loan: Another option is a HomeStyle loan from Fannie Mae. It’s a government-backed mortgage that allows you to renovate your home.

FAQs About Hard Money Loans

Let’s explore some commonly asked questions about hard money loans.

What is a hard money loan example?

The most common examples are developers and house flippers who need cash flow to help fund their next real estate investment. Real estate investors use these loans for funding since the funding time frame is often much shorter than mortgage loans.

What are the risks of a hard money loan?

The biggest risk of a hard money loan is missing payments or not selling the house in time to cover the loan. Because of its higher interest rates, upfront costs and shorter repayment period, hard money loans can dig investors deeper into debt if they don’t have a plan to cover the loan if the market turns down and housing prices drop.

What are the typical terms for hard money loans?

Hard money loans typically offer repayment terms of 12 – 24 months and loan amounts ranging between 70% and 80% of the appraised value of a property. If the loan is used for renovations, borrowers can get up to 100% of their costs covered.

The Bottom Line: Hard Money Loans Can Be Risky

Hard money loans can be a useful tool if you need financing through a less traditional route. However, these loans have high interest rates, and there is a significant amount of risk if you can’t repay the loan.

If you’re looking for alternative financing because your mortgage application was denied, consider exploring other options, including rebuilding your credit or applying for a Federal Housing Administration (FHA) loan. With an FHA loan, a home buyer with a less-than-stellar