A hard money loan is an alternative to a conventional loan from traditional lenders, such as banks. Or credit unions. Hard money lenders are usually private individuals or companies. This loan is not as strict about your credit score, income, or ability to repay the loan. Instead, hard money lenders look at your collateral. If you default on the loan, hard money lenders will get their investment back by seizing the collateral and selling it.
In general, hard money loans are short-term loans, usually between one to five years, with higher interest rates than traditional loans. They are good options for house flippers or developers who fix up properties to sell them again. These borrowers own the property just long enough to increase the value and then repay the loan within a short time, such as a year.
The approval process for a hard money loan is much faster than the approval process of a conventional loan through a bank. This is because there is less emphasis on investigating a borrower’s credit history and verifying his income.
In fact, the lender is more interested in the borrower defaulting because the property has a higher value than the repayment. This is one reason why moneylenders calculate the market value of the property after the anticipated renovations, which is also known as the “after repair value” or ARV.
Because hard money loans are usually private individuals or companies, there is more flexibility in the underwriting process. These private investors tend to evaluate each loan individually on a case by case basis. As a result, applicants can negotiate terms of the loan, such as repayment schedules.
However, hard money lenders are still subject to federal and state laws as well as policies set forth by the Federal Reserve.
Hard money loans are more expensive. Borrowers usually only choose this option if they need money quickly, such as in the event of foreclosure but they have substantial equity in their home, and likely cannot get traditional funding. The interest rates are significantly higher than other loans, even into the double digits. Additionally, you will need to pay approximately 3% origination fees as well.
Most hard money loans will only approve 50% to 70% of loan-to-value ratios. As a result, you will need assets or substantial equity in a property. This ratio is starkly lower when compared to 80% LTV for conventional mortgages and as high as 97% LTV for Fannie Mae guaranteed loans.