What is a hard money lender? The real estate term may conjure up visions of crooked-nosed guys who’ll cut off a borrower’s pinkie finger for flaking on a hard money loan. But you can rest assured that, despite the “hard money” moniker, these professionals aren’t thugs. In fact, these lenders fill a legitimate niche in the housing market for quick, asset-based home loans. And they loan money for massive real estate investments and regular homes alike.
What is a hard money lender?
There are many types of money lenders. To understand “what is a hard money lender,” it’s important to know what a hard money loan is: It’s simply a short-term loan secured by real estate.
Back to the question of who and what a hard money lender is: “It’s synonymous with a private investor,” says Don Hensel, president of North Coast Financial, which specializes in hard money loans. “A lender could be an individual, a group of investors, or a licensed mortgage broker who uses his own funds. This differs from a bank that uses money from its depositors.”
Benefits of a hard money loan
Why would any potential borrower opt for a hard money loan from a hard money lender instead of getting a mortgage through a traditional loan from a bank? Because hard money loans are generally less of a hassle than those from traditional lenders, especially when it comes to real estate investments. The flip side? Hard money loan rates are much higher, and you borrow the money for only a short period of time.
Hard money lending is especially popular for the following people:
Flippers: If a house in disrepair comes on the market and it looks like it could be fixed and flipped in several months, most borrowers prefer not to go through the hassle of taking out a 15-year loan on the property. Instead they take out a fix-and-flip loan, aka a hard money loan, to buy and renovate the investment property with an aim to repay the lending party for the money loan within one year.
Builders: Many contractors use hard money to buy a lot, build on it, and then sell the new real estate and pay off the loan quickly.
Real estate investors: On occasion, a real estate investor will come across a killer deal on a property that needs to be snapped up pronto. If the real estate investor doesn’t have the money on hand to snag the asset, a loan that’s short-term can be fast-tracked by a hard loan lender, who is, in effect, a real estate investor as well.
People with credit issues: Borrowers who have cash on hand for a down payment for what will likely be an owner-occupied home but have been rejected by a bank for a conventional loan—or have had a foreclosure, default, low credit score, or other red flag on their recent credit report, but have some cash on hand—can use hard money to buy a property that would be unavailable to them otherwise.
So let’s say you lost your job several years ago and your house went into foreclosure. Since then, you’ve found a great position and are happily employed. You’ve also found a killer deal on the perfect real estate, but there’s a problem: Few banks will grant you a mortgage with a foreclosure on your record.
Chances are you can find a lender who works with hard money who will give you the opportunity to buy that real estate before it slips away. You can then refinance with a traditional mortgage once time has passed and your credit score improves.
“The higher interest rates may seem scary at first, but the benefits of getting a loan funded quickly and being able to obtain financing when all the banks have said ‘No’ will far outweigh the extra cost,” says Hensel.
The closest thing banks have to a hard money loan is a bridge loan, but qualification for one may be more difficult.
How borrowers get a hard money loan
To find hard money lending options and explore hard money loan rates, ask your Realtor® for suggestions. You could also check Biggerpockets.com‘s directory of hard money lenders across the U.S. But first, you should know how they work.
The loan terms for hard money are usually much shorter; from six months to one year is most common, but sometimes they can go up to five years. And, as you would expect, interest rates are considerably higher, usually ranging from 12% to 21%. Most lenders of hard money also charge points upfront in addition to high interest rates, where 1 point equals 1% of the loan. From 3 to 6 points is typical for a hard money loan.
So if you borrow $100,000 from a hard money lender, you would pay $1,000 per point charged, which would likely be an extra $3,000 to $6,000 upfront, in addition to the interest you’ll be paying until the end of the loan.
Down payment requirements on real estate for hard money loans are also different. You can expect to receive about 60% to 75% of the property value you intend to purchase. If you’re looking at a $200,000 property, for example, the most you’ll probably be allowed to borrow would be $150,000, meaning you’d have to pay $50,000 upfront.
On the other hand, because you’re not doing all of the paperwork and extensive qualifying procedures required by big banks, you can usually get a hard money loan much faster. In many cases, it could take as little as one week.
Risks of a hard money loan
Once you can answer “what is a hard money lender,” you might be tempted to contact one. But you should use caution if you decide to go the hard money route. Make sure you take the time to look into the reputation of the hard money lender, and have an experienced real estate attorney review the paperwork. While there are many legitimate lenders of hard money offering loans, there are also predatory ones who try to take advantage of borrowers.
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