You are ready to buy a piece of property. There is only one problem; you need someone to lend you money. Depending on what you are buying and your intentions with the property after the sale will decide what type of financing you need.
There are several significant differences between hard money loans and traditional bank loans. Hard money loans are short-term, usually between 6 months and 2 years. A conventional mortgage is typically amortized over 25 to 30 years. Hard money loans carry a significantly higher interest rate than do traditional loans. Hard money loans are backed by “hard” assets (property) used as collateral, while banks use your credit to secure your loan. So, which one do you use? Hard money loans are meant for investors and traditional mortgages are intended for owner-occupied residences.
In order to be approved for a hard money loan, lenders require that estimates are provided by the contractors that will be fulfilling the renovations. Lenders will approve only those expenses that are directly related to increasing the value of the property.
After approval on a hard money loan, funds are distributed in predetermined amounts which are called “draws.” A “draw” is an amount of money that will cover a portion of the renovations. Typically, this is set on a schedule.
When a borrower applies for a bank mortgage, the underwriting departments look at income to feel confident the monthly payments will be met, and an appraiser checks to make sure the monthly payment won’t exceed the value of the property. It takes anywhere from 30 to 90 days for the underwriting committee to approve the loan and close on it.
Hard Money Loans Work Differently
Unlike a traditional bank, a hard money lenders focus is on the deal (the property, its value and potential to make a profit.) They want to be sure the borrower budgeted appropriately for the rehabilitation. They will send an appraiser to the property to determine the after-repair-value. They will do their homework to be certain this property will turn a profit so the borrower can repay the loan on time. Hard money loans are generally funded in 5 – 14 days. That’s a much faster close than a traditional loan.
Hard money loans terms vary depending on the geographic area and the lender. Interest rates are anywhere from 8%-18% and loan origination fees are anywhere from 1 to 4 points (or percent). Loan terms between different lenders are usually pretty competitive. However, lenders are more flexible with investors doing repeat business with them.
All loans have pros and cons. Some benefits and disadvantages of hard money loans are:
Pros: Loans close quickly, which is important in the real estate market. It’s easier to get financed for a loan that uses property value as collateral, and approval isn’t contingent upon the borrower’s creditworthiness.
Cons: Borrowers will pay higher interest rates and have higher additional loan origination fees. Because the lender is using the property as collateral, if the project isn’t finished the borrower will walk away empty-handed. And, be prepared for unforeseen expenses.
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About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 43 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.