What Is a Hard Money Loan & How Does It Work?
A hard money loan is a form of short-term financing for real estate and typically has easier qualification requirements compared to traditional forms of financing. It can also be easier to get approved if you have bad credit. Unlike traditional loans, hard money lenders can issue financing on properties that need repairs.
These flexibilities, however, usually come at the cost of higher interest rates and fees. As a result, hard money loans are often considered a last resort for mortgage financing. Repayment terms are also short, rarely exceeding 24 months. Funds are commonly used by fix-and-flip or fix-and-hold investors to conduct repairs and renovations. The loan is then paid off when the property is either sold or refinanced and replaced with a different loan.
Rates, Terms & Qualifications of a Hard Money Loan
The rate you get can depend on the lender you choose, the details of the property being financed, and your business qualifications. Below is a summary of how each of these can impact your rates.
- Lender: A lender may have policies that dictate the minimum and maximum interest rates offered. In some cases, this may also be dependent on an index, such as the US prime rate.
- Property: Rates are often tied to the level of risk associated with issuing a loan. As a result, properties that are in good condition or have the potential to be large-income producers can qualify for more competitive rates.
- Business qualifications: Common items a lender can evaluate include your credit scores, time in business, collateral, and assets. Financial ratios, such as your debt service coverage ratio (DSCR) or debt to income (DTI) ratio, may also be evaluated.
For more details, check out our guide on commercial real estate rates.
Most lenders have internal policies that dictate the minimum and maximum loan amounts that can be issued. Minimum loan amounts are often implemented to prevent the possibility of an excessive amount of loan fees being charged in relation to the amount being financed. Less common are lenders that have no set maximums and can offer nearly any loan amount as long as your company can qualify.
Hard money loans are short-term loans, so you’ll rarely find loan terms exceeding 24 months. While shorter terms often result in higher payments, many hard money loans are interest-only, which can reduce any pressure from a cash flow perspective.
At the end of the repayment term, you’ll be expected to make a balloon payment, which is a lump-sum payment to pay off the balance of the loan. This is often done by refinancing to a more permanent type of loan.
These ratios deal with how much financing you can get based on things like your down payment amount, the property’s value, and repair costs.
- LTV measures your loan amount in relation to the property’s current value.
- LTC measures the loan amount in relation to the total costs associated with purchasing and repairing the property.
- ARV measures your loan amount in relation to the property’s projected value once all repairs have been completed.
You can learn more about how to calculate each of these ratios in our corresponding guides.
Hard money loans can often be funded quickly. Exact funding speeds can be impacted by the total volume of applications received by the lender, the complexity of your loan application, and how quickly you respond to a lender’s requests for more information.
Hard money loans have lower credit score requirements than many other forms of traditional financing. Credit scores are impacted by different factors, such as your payment history, the amount of debt owed, the length of your credit history, and the new credit you’ve recently obtained.
To learn more and get tips on how to boost your score, head over to our guide on what a bad credit score is.
Since hard money loans are often used as a form of investment property financing, some lenders may require a proven track record of success as a way to minimize risk.
Pros & Cons of Hard Money Loans
Who Should Consider a Hard Money Loan
While a hard money loan may be more expensive in the short run compared to many other forms of financing, it can offer long-term benefits to certain investors. It could be a good fit if you
- Want to flip a property for profit: A hard money loan can be well suited if you believe you can purchase a property, conduct repairs or upgrades, and then resell it for a net profit. You can use our hard money loan calculator to determine the total costs involved with getting this type of loan.
- Have bad credit: Traditional loans with competitive rates typically require fair to good credit. If you have a low credit score or otherwise cannot meet the eligibility criteria for these loans, a hard money loan can provide the flexibility needed with lower credit score requirements.
- Have income that is ineligible or insufficient for traditional financing: Traditional lenders may be more strict when it comes to evaluating the type and amount of income that will be used to repay a loan. This may be due to the need to adhere to investor or secondary market requirements. Hard money lenders do not have those requirements and have a greater level of authority in determining whether to issue financing.
- Want to finance a distressed property: Traditional loans typically require real estate to be in good condition with no needed repairs, safety issues, or health hazards present. Hard money lenders, however, can finance distressed properties.
- Need to finance repairs to an income-producing property: If you find a property with good income-producing potential, it may be worthwhile in the long run to finance it with a hard money loan. Funds can be used to conduct repairs and upgrades, after which they can be replaced with a more affordable, permanent traditional form of financing.
- Seek funding fast: Hard money loans can be funded quickly, often within 7 to 10 days. This can allow you to compete with all-cash buyers and acquire properties before they get purchased.
A hard money loan can be obtained by following the steps below.
Before you choose a hard money loan, you should consider how you intend to use the funds and whether other types of loans could be more well-suited for your needs. You can make this determination by evaluating things like the available loan amounts, repayment terms, interest rates, and loan fees.
Understanding your basic qualifications can save you time from applying to lenders where you will be unable to get approved. This is also an opportunity to have compensating factors documented and ready to provide to lenders as it can help expedite the approval.
Different types of lenders can include online lenders, banks, and business loan brokers. Each has differences in quality and availability of customer service, flexibility of qualification requirements, rates, fees, and number of physical office locations. Although more difficult to find and get, private money lenders are another option.
Once you’ve selected a lender, you’ll need to apply and provide the required documents. An exact list of required documents can vary from lender to lender. It can also be dependent on your company’s unique circumstances. Common items, however, generally include items that support your company’s financial ability to repay, assets, and a list of all debts and financial obligations.
For more details such as tips on getting the best rates and insights on how you can improve your approval odds, view our detailed guide on how to get a small business loan.
Hard Money Loans vs Alternatives
Conventional Mortgage Loan
A conventional mortgage loan uses your personal home as collateral. If you have sufficient equity, you can do a cash-out refinance and use the proceeds to purchase another home that otherwise might not qualify for traditional financing.
We recommend working with a company like Visio Lending for this type of loan. It offers financing for vacation and investment properties, including office buildings and fix-and-flip homes.
Commercial Bridge Loan
Bridge loans are commonly used to fund the costs associated with repairing and rehabilitating a property. Once the repairs are completed, bridge loans are often paid off when the property is sold or replaced with a more permanent type of loan. Although similar to hard money loans, bridge loans have stricter eligibility criteria but can offer more competitive rates in return.
For this type of loan, Kiavi is an excellent option. It offers programs that have no income verification or appraisal requirements, and funding speeds can also be as fast as 10 days.
Portfolio Loan
This is a type of loan that a lender does not sell on the secondary market. Rather, it retains the loan in its own portfolio. As a result, portfolio lenders can have more flexibility when it comes to determining eligibility criteria, as they do not need to adhere to investor or other third-party requirements.
CoreVest is one of our recommended lenders for this financing type as it has no minimum credit score requirement. It also has different loan programs depending on the type of property you’re looking to finance.
Frequently Asked Questions (FAQs)
A hard money loan is a form of short-term financing. Funds can be used to cover the costs associated with rehabilitating a property. Hard money loans are often used by fix-and-flip and fix-and-hold investors.
Compared to a traditional loan, getting a hard money loan is typically much easier. Hard money loans often have lower credit score requirements and more flexibility when it comes to evaluating credit and assets. In exchange for this flexibility, however, rates and fees tend to be higher.
Closing costs for a hard money loan tend to range from 2% to 5% of the loan amount. Since this type of loan represents a greater risk to lenders, interest rates also tend to be higher than traditional forms of financing.
Bottom Line
Funds received from a hard money loan can be used to repair, upgrade, renovate, and rehabilitate a property. Since hard money loans are a form of short-term financing, you’ll need to ensure that the loan can be paid off on time. Hard money loans are often used by fix-and-flip and fix-and-hold investors who pay off the loan by either selling the property or refinancing to replace it with a more permanent loan.
Although hard money loans often have higher rates and fees, well-qualified businesses can still get competitive pricing. Kiavi, for instance, is a lender we selected for our list of the best hard money lenders due to its low rates, flexible eligibility criteria, and easy documentation requirements.
