A hard money loan refers to a type of loan. However, what makes it different from other types of loans is that it is secured on real estate. In addition, they are considered as short-term bridging loans or as a last resort. Basically, they are used in various real estate transactions. The lenders are companies or individuals, not banks. Read on to know more.
Key learning points
Below are some of the salient features of these loans.
- They are mainly used for real estate transactions. And this money comes from a company or private individual rather than a bank.
- Usually this type of loan is provided for a short period of time. The goal is to raise money quickly at a lower ration of LTV and higher costs.
- Since these loans are not traditionally executed, the financing time is usually shortened quite quickly.
- It is interesting to note that the terms of these loans are negotiated between the borrower and the lender. In addition, these loans use the property as collateral.
- Although repayments can lead to default, they still leave a lot of profit for the lender.
How does a hard money loan work?
Usually, the terms of hard money loans are based on the value of the property, not the creditworthiness of the borrower. Since conventional lenders like banks are not the lenders, private lenders or companies are most interested in this business.
These loans can also be a good choice for real estate flippers who have plans to renovate and re-sell a home. Here you may think that the costs of this type of loan are quite high. But the great thing is that the extra costs are compensated because the loan is paid off fairly quickly. In most cases, the loan is provided for a period of 1 to 3 years. In addition, they also offer many advantages.
Apart from this, this type of loan is also considered a great investment. You can find many people who have done this business and are happy with the practice.
Unlike the bank financing or the financing programs offered by the government, the cost of these loans tends to be quite higher for a typical buyer. However, these costs reflect the higher risk that the lender bears. But the good thing is that the extra cost is worth it, as the money is available quickly. The approval process is less strict and the repayment schedule is also quite flexible.
These loans can also be a good choice to deal with turnaround situations. For example, if you need quick cash for short-term financing, but you have a bad credit score, you can give it a try. Since the amount is spent quite quickly, you can use the money to avert an execution, for example.
Pros and cons
Now let’s look at some of the pros and cons of hard money loans.
First of all, the approval process is quite faster as opposed to the process of a mortgage or a conventional loan. The point is that private lenders are interested in this kind of business because they can make quick decisions without going through a lot of checks. In other words, they won’t check your credit history. These are the steps that slow down the process and keep the borrower waiting for weeks.
Usually, these investors only care about the repayments. In addition, they have the option to resell the property in the event that the borrower does not pay and becomes a defaulter.
Another advantage is that the lenders do not apply the conventional underwriting process. Instead, they evaluate all cases one by one. Often, applicants can sit with the lender and discuss the repayment schedule based on their circumstances. Apart from this, borrowers can take advantage of many opportunities during the time they have. So this is another big advantage that you can enjoy if you choose this option.
Since the property is used as security against default, these loans have lower LTV rations as opposed to the regular loans. This ration is between 50 and 70% in contrast to the ration of regular loans, which is 80%. However, if you are an experienced pinball player it can be even higher.
In addition, the interest rates of these loans are also higher. For subprime loans, the interest can be even higher. For example, the rates of hard money loans in 2019 were between 7.5 and 15% based on the period the loan is provided. In contrast, prime interest was only 5.25% over the same period.
Another drawback is that due to compliance rules and regulatory oversight, these lenders are not allowed to lend against owner-occupied properties.
Hope, now you understand what hard money loans are and the pros and cons associated with it. For more information, please contact your mortgage advisor.
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