While the term “hard money loan” might make you think of some shady loan shark lurking around a corner in a dark alley, charging exorbitant interest rates and not-so-pleasant terms if you can’t repay, that’s not the reality, although in some cases it might have a few similarities.
What a Hard Money Loan Is
Hard money lending simply refers to a short-term loan that’s secured by real estate, such as a new home in Brampton. As opposed to conventional lenders, like a credit union or bank, they’re funded by private investors or a fund of investors.
Terms for hard money loans are short, typically around 12 months, but they can be extended for longer terms of up to five years. They require monthly payments of just interest, or interest and some principal, with a balloon payment at the end of the loan term. The amount one can borrow is primarily based on the value of the property that secures the loan. The lender for these loans are primarily concerned with the property’s worth rather than the borrower’s credit as the property is being used for collateral. If something goes wrong and you can’t repay the loan, the hard money lender can get their money back by seizing the collateral and selling it. Interest rates for these loans are generally much higher than a traditional loan.
Reasons to Obtain a Hard Money Loan
If the interest rate is higher for a hard money loan, why would you even consider it? Many people who want to invest consider these loans if they have a poor credit score with perhaps a foreclosure or other negative items on their credit report. If you hope to buy an investment property, the lender won’t be too concerned about your credit and will often lend as much as the property used as collateral is worth.
A hard money loan can often be obtained much quicker as lenders don’t have to spend as much time going through every item on that application, reviewing bank statements, verifying all income, etc. It also provides the ability for the borrower to close deals faster that others can’t, which gives them a leg up in a hot market with multiple offers. These loans make the most sense for shorter term loans like fix-and-flip investments. You’ll own the property just long enough to increase the value, sell it and repay the loan, usually within 12 months or so.
The Downsides to Hard Money Loans
As mentioned, the interest rates on hard money loans are typically much higher than conventional loans you’d get from a bank or credit union, ranging anywhere from 10 to 15 percent, depending on the lender and risk factor. They also require a bigger down payment, usually at least 25 to 30 percent, or maintaining 25 to 30 percent equity in a property already owned, such as the case for refinancing. Bank loans usually require a down payment of around 20 percent, but programs like FHA allow for much smaller down payments.
While you might run across a high-risk money lender willing to loan hard money with no money down, these are usually a bad idea. It leaves the hard money lender with little or no security on their investment, and if something goes wrong the borrower can be forced to let the lender foreclose or provide them with a deed in lieu of foreclosure.