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Hard money loans are loans from private investors that enable mortgage borrowers to attain financing to purchase, remodel, or reconstruct their homes when the conventional mortgage loan options are not available to them.
Hard money loans are short-term mortgages secured by real estate. The loans are funded by private investors instead of institutions like banks and credit unions. The loan terms are often 1-2 years, but terms of 3-5 years can be arranged as well. Hard money loans require monthly payments while the loan is outstanding with a balloon payment (remaining balance of the loan) due at the end of the loan.
The hard money loan amount is limited by the value of the property being used as collateral for the loan. Hard money lenders often limit the amount they are able to lend at 75% of the value of the property being borrowed against. For example, if a lender valued a property at $400,000 they would be able to lend up to $300,000 on the property if they stuck to the 75% loan to value (LTV) ratio.
Hard money loans have few requirements. Many property owners and real estate investors choose to use them because of the lack of stringent requirements and the speed at which the loans are funded. The main requirements for a hard money loan are having enough equity in the property and having sufficient cash reserves for holding costs.
Because hard money loans are asset based, they primarily focus on the property's value as well as the borrower's equity (down payment) in the property. In contrast, the income history and creditworthiness of the borrower are the main focus of conventional lenders. As discussed previously, a minimum of 25% down is often required for a hard money loan. In the case of a borrower refinancing a property, the borrower's equity in the property will need to be at least 25% or more. The reason for the strict down payment / equity requirements is that this is the lender's security for the loan. It gives the borrower the incentive to protect their equity and make the agreed upon payments as well as make the balloon payment at the end of the loan term.
Another requirement is that the borrower has sufficient cash reserves in order to pay the various holding costs (monthly loan payments, insurance, taxes, HOA, etc.) while the loan is outstanding. In some cases, the lender may be able to increase the loan amount and hold back funds to ensure the loan payments and other necessary payments are taken care of if the borrower is currently low on cash reserves.
Hard money loans can be obtained for various property types including single family residential, multi-family, industrial, commercial and land. The majority of hard money lenders will only lend on investment properties and not provide loans for owner occupied residential properties. This is because of the recent increase in government regulations and requirements that make funding these loans much more complicated and time consuming. There are hard money lenders who are able to fund owner occupied residential properties but they will be harder to find. These types of loans also have multiple mandatory rescission periods as required by government regulations, which unfortunately increases the amount of time to fund the loan.
The interest rates and fees required for hard money loans vary based on the lender. Generally, interest rates will range from 8-12% and points range from 2-4, although there may be hard money lenders who charge much more in certain situations. As with anything else, competition will bring down the cost of the loans. The more lenders who lend in an area, the more likely the interest rates and loan fees will be lower.
In addition to points, some hard money lenders will charge other fees such as processing, document or underwriting fees. When considering a hard money lender to work with, borrowers are advised to ask about all fees at the beginning in order to avoid an unwelcome surprise later in the loan process.
It's in a borrower's best interest to first pursue a conventional home loan from a bank or credit union. A conventional loan is always going to be the lowest cost option. If the borrower's loan request has been rejected by conventional lenders, they can then pursue other options, such as hard money loans. Once the property is secured with the help of a hard money loan, the borrower can begin working through issues to refinance to a long term conventional loan.
There are numerous reasons a conventional lender will reject a borrower's request including recent foreclosures, short sales, loan modifications or bankruptcies. Another common reason for a borrower not being able to obtain a bank loan is low credit scores. Issues with employment may cause a bank to deny a loan request if the borrower has less than 2 years of employment with their current employer or if they are self-employed.
These are all common issues that prevent a bank from extending financing to a borrower but none of these issues would prevent a hard money lender from providing a loan.
When a homebuyer acquires a home with a hard money loan they must plan for refinancing into a lower cost conventional loan in the future. Hard money is only for short term use. If the borrower had low credit scores that prevented them from obtaining conventional loan they must begin repairing their credit. In other situations (foreclosures, short sales, loan modification, bankruptcy, employment history, etc.) the borrower may just have to wait until enough time has based for them to qualify for a bank loan again.
Jeffrey A. Hensel ([email protected] ) is a Hard Money Lender at North Coast Financial, Inc., a hard money lending firm based in Oceanside, California with over 35 years of experience offering various types of hard money loans including bridge, fix and flip, refinance, investment property, estate and purchase loans
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