Very few people go through life without having to finance a loan to make major purchases. Whether it is for education, a car, homeownership, or to pay major medical costs, loans assist us in meeting our financial goals. However, loans can be a tricky process, and despite the need for them, they are often tailored toward one type of financial profile. This means, for most, your credit score must be above average, your credit report free from any blemishes, your income-debt ratio must be low, and you must prove a history of reliable income. In truth, you could make $220,000 a year and be denied for a loan if your credit history is not up to par. This makes it difficult when you are in an emergent situation and need access to funds quickly for your next venture.
This is usually when “hard money” comes to play.
What is Hard Money?
For most, when they purchase a home or automobile, they go through what is referred to as traditional financing. This is when the bank fronts the loan of your purchase, your monthly costs are determined by your credit worthiness, and you pay monthly payments plus interest until the items are paid off completely.
This loan is built around your credit profile and based on your credit report, history, and monthly income. In financial lingo, this is referred to as soft money, or money that was easy to obtain and did not cost you or pose threats to your assets or property. Soft money loans are easier to pay off, can be short-term or long-term, are not designed to decrease a person’s equity, can be used for many reasons, and are protected by a wide variety of regulatory systems and checks and balances.
When a private lender bases the amount you qualify for on owned collateral, usually property, this is referred to as hard money. Hard money is specific to investment and real estate. Typically, hard money loans are given to fund short-term, investment properties—but there is always an exception to that rule. With any short-term loan, the interest rates are often higher than what you would find through traditional loans, so you pay more in the long run. You also lose your property or collateral if you do not live up to the terms of your loan and face steep interest rates that are nearly impossible to pay. The “hard” in hard money, refers to how difficult it may be to pay off the loan due to high interest rates and fees. Additionally, it refers to overall risk associated with this type of loan.
Right now, the average mortgage rate is 2%. The average hard loan rate falls between 6-12% and this is during an economic downturn. When the market is thriving, and the average home loan is between 4-6%. hard loan rates can more than triple.
However, unlike soft money, hard money lending is straightforward. You can usually secure funds quickly without all the hoops and mounds of paperwork and you do not need good credit to obtain one. This gives it an edge over traditional funding and allows startups or new ventures to become established and realized, keeping hard money lending relevant in todays market.
What can I use Hard Money for?
Most hard money loans are awarded to real estate ventures that are in the business of acquiring homes and turning them over for profit. Hard Money loans usually have a high interest rate, thus reinforcing why short-term lending is optimal—so you are not pit falling into a payment schedule you cannot afford. However, hard money is not only restricted to real estate ventures, many use it to stave off foreclosure despite the fact their new loan comes with higher payments and larger interest rates.
Hard Loans are commonly used for:
- Mortgage refinancing, in the case of foreclosure
- Equity loans or second loans you take out on a property to provide you with a bit more cash (often seen as a home improvement loan), extending the life of the loan
- Bridge loans: short term loans used in the interim while between financing. This often occurs if you have one loan out on one property, are waiting for it to be sold, and need another for additional properties or ventures
- Cash-out refinances happens when you take a loan out on a property you have been paying on so you can cash out on its worth. For example, if your property is worth $286,000 and you refinance for $300,000 you would receive $14,000
There is a financial blog rumor that you can obtain a hard money loan (remember these loans make you front collateral for cash, so they differ from a payday loan or a short-term loan) for any amount you wish as long as the lender feels you are worthy investment, but I have not been able to locate a single source outside the realm of real estate that deals in fronting personal hard loans for the everyday person. However, if you have property as collateral and want a loan it is entirely possible you would be approved—in terms of hard money, this is the bottom line.
Lastly, hard loans are useful when you need money fast and cannot access a bank loan, or do not have the credit to go through traditional financing.
Are Hard loans the Same as Purchase Money Loans?
There is some confusion around the difference between hard money loans and purchase money loans because hard money is often used in real estate. However, purchase money loans, sometimes referred to as purchase money mortgages, are money loans that the seller of a home issues to the buyer of a home exclusively for the purposes of purchasing their property. You may have heard it called owner or seller financing. In this situation the seller of the home assumes the role of the bank and sets their terms, including creditworthiness, allocated down payments, and monthly payments involved in the loan.
Hard money loans use real estate as collateral but can be used for many different things. For example, many house flippers (buy a house for cheap, fix it up, sell it for more) use hard loans to fix up their houses. The money might have gone to the real estate venture but was not allocated exclusively to the purchase of the home. You are also not purchasing something from the seller. Hard money loans are short-term, cash loans, while purchase money loans are much longer and exist for the sole purpose of purchasing a home directly from the seller.
Where Can I Find Hard Money Lenders?
Unlike banks or Credit Unions, hard money is not readily available in every community. Hard money lenders are usually investors and therefore do not operate like the banking system. However, locating a lender is not difficult to do. In fact, it is as easy as performing a web search.
Unlike bank financed loans, hard money loans are not attached to the same protections and regulations, so choosing a lender of repute and established track record is vital to your financial health. It is also extremely important to read the fine lines, ask the tough questions, including “what may happen if I cannot pay this within the time limit?” and be aware of possible outcomes. Be sure what was explained to you during your Q &A sessions is visible, clear, and in writing. Checkout the Nationwide Multistate Licensing System & Registry and National Real Estate Investor Association for information on your lenders license and client experiences.
Always exercise due diligence when working with a hard loan lender.
What is a Predatory Lender?
Predatory lending refers to the practice of giving loans to individuals that will have difficulty repaying them due to high interest rates and fees. This way they sit on the loan for longer, making the lender money. Predatory lending is designed to make the lender as much money as possible before the end of the loan.
A predatory loan is easy to get but impossible to pay off.
Predatory loans are designed to make the lender money and target vulnerable populations who have little money to begin with. While hard money lenders are not always predatory, and there are legitimate, reputable lenders who work with people every day—hard money does not always present itself that way. In the past, hard money loans sat at the forefront of moneymaking operations designed to attach people to properties they could not afford so the lenders could foreclose and make money from the properties.
That scenario alone demonstrates a vital need to know your lender.
Be sure your terms are reasonable, affordable, and worth it.
However, to reiterate, not all hard money lenders are predatory (outside the nature of high interest, short-term loans). There are trustworthy lenders available for you to work with, and when used responsibly they can be a means to an end.
Breezy Application Process
One of the perks of a hard money loan is that it is not a bank loan. Yes, you read that right. While bank loans are often secured, low interest, and provide you with valuable protectors, they can be evasive, take thirty days or more to go through, and are often based solely upon your credit score. Bank loans are also capped! They will never loan you more than you can afford—mathematically speaking. There are a lot of factors banks consider before fronting the costs of homeownership or any other financed purchase.
Hard loans do none of that. Hard loans cut out the red tape.
You do not need thousands of dollars for a down payment or go through the motions of trying to secure a loan based on credit and employment history. The real estate market is an everchanging gig, so hard loans keep the ball rolling despite the fact you might have had a bad quarter or season. Hard loans are based upon the value of collateral, which makes the application process easier than ever.
Another reason hard loans are not so hard… is because they are sourced from lenders and do not fall under the rules and regulations of federal lending. This is also why you can have your money in as little as one to two days. Some even offer same day payouts! This is opposed to a bank’s month-long process helps alleviate the time constriction often seen in real estate. Hard money gives you cash when you need it most, which is especially useful if you are on a deadline and need to keep things going so you do not lose money in the end.
Is Hard Money Risky?
Risk is usually a subjective term, driven by the individual’s perceptions, morals, culture, values, and beliefs. What is risky for someone may pose no risk to another. However, when it comes to finance, risk is the mathematical force that determines whether you will one day own your own home, be able to take out credit for any reason, or rent your next apartment.
When you finance a loan from a bank, they evaluate your risk factor. The bank looks hard at your creditworthiness, your number, employment history, recent loan attempts, inquiries, your debt-income ratio, yearly salary, your dependents, and so much more. If after all of that they find you worthy for a loan, all those factors decide what interest rate they offer you and outline the terms of your loan.
When you finance a hard money loan, they look at your property value, either approve or deny your request, and let you assess the risks.
In hard money lending, if you fail to repay your loan or abide by the terms of your loan, your lender receives your property. There is no risk to them. You are paying higher than average rates, so they are making money from your loan—and if you fail to keep that momentum, they get your collateral too. Hard money lenders might phrase this as a win-win.
But for hard money loans to work, it must be a win-win for you.
The risks must be lower than the rewards. The benefits must be higher than the repercussions… And above all, make sure you can afford it within the term of the loan, and that the high interest rates will pay off in the end, so you do not just break even.
Another risk factor to consider is that hard money loans do not have to abide by federal regulations and therefore are very much at the behest of the lender. There are no checks and balances. You have little protection in this situation, which is something you need to consider going into an agreement with a hard money lender.
Are hard money loans risky? The short answer is yes. However, when used responsibly, they hold their relevancy in today’s market. They can provide short term, financial solutions, and relief to those facing challenges with traditional financing. Hard money loans are also a valid option for those who need a flexible cash solution without purchasing parameters banks often attach to funds.
Hard Money Overall Pros and Cons
Hard Money Pros:
- you work with a person not an institution
- short turn around (get your money in days)
- no credit needed, bad credit is fine
- Based in property and collateral
- no red tape
- no spending restrictions
- easy approval
Hard Money Cons:
- High interest rates
- No protections or regulations
- You lose your property if you cannot pay
- You are subjected to inflated interest rates if you default on your terms
- You pay more than you would at a bank
- Loans are short term and inflexible
- You must search out and find a reputable lender
- High risk
The Bottom Line
If you are considering a hard money loan, exercise due diligence, be sure your lender has a proven track record, shop around for lower interest rates and better terms, assess your risks and be sure it is a win-win for you (not just your lender), and always consider your losses. Is your collateral worth the loan you are taking?
While hard money loans should be considered on an as needed bases, they are not without their place and purpose in today’s market. When used responsibly, hard money loans can alleviate many obstacles and prevent many barriers that are often associated with traditional loans.