Real estate investments are a great way of building wealth and are effective for portfolio diversification. Getting a loan may be a good idea when looking for money to kick start your next investment project. Since there are many lending options available, it’s essential to understand how the different forms work.
Hard money lending can be an attractive option when you want quick funding or when you can’t access traditional loans. Before looking for a lender, it’s imperative to understand how these loans work and whether they suit your situation.
What Is a Hard Money Loan?
A hard money loan is a non-conventional short-term loan offered by private lenders or individuals who accept the property as collateral. This funding option is primarily standard in the real estate sector and is used as an instrument for financing investment projects. It can be a great move for investors who acquire property to develop and sell for a profit.
Like most conventional mortgages, hard money is guaranteed by the asset it is purchasing. But unlike bank mortgages, hard money funding has a quick and less stringent borrowing process –making them ideal when you want to buy a property quickly. Instead of several months, the approval can happen in a few days.
Hard Money Interests and Points
Hard money lending involves a higher risk compared to traditional loans from banks. Owing to this risk, hard money loan rates are higher compared to conventional loans. Ideally, 30-year bank mortgages have a fixed rate of about 3.01%. On the other hand, hard money providers charge between 8%-15%.
Lenders charge a fee for providing the credit services, and these fees are known as points. Generally, the points can range anywhere from 1% to 4% of the loaned amount. Points are used as the origination fee and can also mitigate the risks borne by the lender. Typically, the lender requires you to pay the points when closing the loan.
Borrower Requirements for Hard Money Loans
Hard money lenders expect borrowers to cover a portion of the property cost using their own money. Mostly, the amount comes in the form of down payments. While the exact payments can vary from one lender to another, most lenders ask for 10% of the property value.
Traditionally, the property’s Loan-to-Value (LTV) ratio determines the amount of down payment for your deal. However, some lenders use the After Repair Value (ARV) to calculate the LTV of the property. This scenario can be suitable when you don’t have enough cash to complete the necessary renovations. But whenever a lender employs the ARV approach, they are likely to charge higher points and interests to account for the higher risks of hard money lending.
It’s also important to note that some hard money providers may not ask for a down payment. Nevertheless, such deals often attract exorbitant interests and fees unless you’re experienced in real estate investment with a proven track record of making quick profits.
It’s prudent to be careful with financing deals with no down payment requirements unless you are sure the property will sell quickly. Since your property serves as the security, there is a high chance of losing the investment if something goes wrong and you can’t raise the agreed hard money loan monthly payments.
When to Use Hard Money Loans
Hard money can help you get started with property investment. Notably, they are a great option if you have a poor credit history and still want to create a home-flipping business. Ideally, the projects happen pretty fast, and it helps to have quick forms of funding. Also, most property flippers sell the house in less than 12 months; therefore, they don’t need long loan terms.
Prospecting investors who want to acquire rental property but can’t access traditional financing from banks may opt for hard money loans. Also, it’s a good option when you have a bad credit history or need more funds than you can get from a bank loan.
Hard money loans are a helpful instrument for investors looking for funding through non-traditional means. They provide an easy route for securing profitable real estate investments. House flippers, real estate investors, and property developers prefer hard money loans for easy and quick financing.
In contrast to traditional bank loans, hard money lenders tend to charge higher interests. However, the higher cost is a tradeoff for quick funding, and loans use the property you’re purchasing as collateral. As such, if your investment doesn’t go as you had planned, the risks are higher.
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