If you're considering a hard money loan, you're probably wondering whether the risks outweigh the rewards. Hard money loans can be a good fit in the right scenario, but there are both pros and cons to consider before borrowing.
Let's discuss hard money loans and the risks and rewards that come with them:
Hard Money Loans 101: What They Are and How They Work
A hard money loan is a type of private loan that’s generally used by business owners, rental property investors, or people who flip houses. With a hard money loan, a borrower receives money from a private lender instead of a traditional government-backed institution. Real estate investors who are unable to obtain loans from traditional banks tend to prefer hard money financing because it provides short-term funding when they need it most.
Anyone hoping to secure a hard money loan must make sure that the loan will cover the entire duration of the project. The loan should not mature before the project is completed and should provide enough funds for any necessary updates, repairs, or upgrades. Now that you understand what a hard money loan is and how it works, let’s take a closer look at some of its pros and cons:
What Are the Advantages of Hard Money Loans?
These are some of the advantages of hard money loans:
- Competitive interest rates: Hard money lenders come with standard lender guidelines, offering short-term loans that will typically last anywhere from 12 months to a few years. Because loan terms can be competitive between different lenders, comparing different hard money loans can land you a better interest rate.
- Speed: Once a borrower and lender agree on terms, the documentation process is relatively quick, and may take just a few days. Speed is critical when a borrower is pulling some much-needed capital out of their properties to inject into their business, or planning to buy a property to flip in a busy or unpredictable real estate market.
- Underwriting Process: When dealing with a hard money loan, the underwriting process is much less intensive and shorter than traditional loans. Why? Hard money lenders are more focused on a property’s value (which is used as collateral), instead of the financial standing of the borrower. This means that the borrower's credit score, credit history, and debt-to-income ratio are not scrutinized as heavily.
What Are the Risks and Disadvantages of Hard Money Loans?
Any type of investment carries some type of risk, and hard money lending is no exception. Hard money lenders understand that real estate buyers rely on this type of loan to finance numerous projects quickly.
Because hard money loans are generally used by investors who don’t want to waste time on the underwriting process, they typically come with more stipulations, such as:
- A higher interest rate: Hard money lenders generally charge higher interest rates to borrowers, because loan terms tend to be significantly shorter than traditional loans. They’re also taking on more risk than a traditional lender. Any payments made are also typically applied to the loan’s interest only, and no portion of the payment is going toward the principal.
- A larger down payment: A hard money loan may require a larger down payment over a traditional loan.
- A shorter loan term: A hard money loan’s term is significantly shorter than a traditional loan. While mortgages can last anywhere from 15-30 years, a hard money loan may have to be paid back in just one to three years.
How Do I Choose the Right Hard Money Lender?
Hard money lenders offer flexibility. They can fund projects that traditional lenders cannot. Hard money lenders also have the ability to customize loans based on the needs of the borrower.
Like any mortgage lender, hard money lenders may differ drastically from one to the next. How can you choose the right one? Here are a few tips:
- Identify your own needs: Seek out lenders that specialize in the type of financing you need. Choose the loan that carries the least risk for you and be prepared to pitch the project you want to fund.
- Stay local: It’s important to find a private lender in your area that has the ability to inspect the property in person. This means you won’t have to waste time informing the lender about the local real estate market.
- Consider the lender’s reputation and experience: Working with a reputable lender helps you avoid scams or mistakes.
Work With a Hard Money Lender That Fits Your Needs
Val-Chris Investments offers private lending services to fit the specific needs of our borrowers. We pride ourselves on giving the highest-quality service to our customers, with a guaranteed fast turnaround. To learn more about our specialized lending services, contact us today.