Hard Money Loans Explained

When it comes to house flipping, financing is often half the battle. With the difficulty of loan approval and the necessity for quick cash, hard money loans can be the best option. They make the impossible possible for those hoping to invest in real estate, but who are lacking in cash flow or credit score. 

Getting approved for a hard money loan is a much simpler process than that of traditional funding because it is not determined by the borrower’s creditworthiness or income. However, hard money also comes with steeper terms, loftier interest rates, and additional fees. In obtaining the funds to flip a house, it is crucial to consider hard money loans in this regard: how they work, why they work, their advantages over traditional financing, and their drawbacks.

What is Hard Money?

As opposed to conventional loans, hard money financing is provided by private individuals or companies, and based solely on the value of the property. A hard money loan is essentially a short-term bridge loan, lasting anywhere from one to five years.

In determining the loan amount, lenders focus on what the property will be worth once renovations are complete, otherwise known as the ARV, or “after repair value.” Where traditional lenders require a good credit score and available income to pay back the loan, hard money lenders are more concerned with the value of the collateral.

The property itself serves as protection if the borrower defaults on the loan. Due to the high risk that the lender takes in offering the funds, hard money loans are typically more expensive for the borrower than what is available through mainstream financial institutions.

Why Use Hard Money? 

The high cost of hard money loans comes as a tradeoff for convenience. Hard money loans allow you to not only bypass a time-consuming application and verification process, but they also allow you to close on a loan and receive funding within a matter of weeks.

Unrestricted by stringent policy or standard underwriting procedures, lenders can assess hard money deals individually, leaving room for flexible term negotiations. Some may even allow the use of personal assets to secure the loan.

When Does It Make Sense?

Hard money is a tool used most effectively by investors interested in renovating and reselling real estate with a quick turnaround time. The ideal hard money user will increase the value of their property, sell it, and then repay the loan within about a year.

For borrowers with insufficient credit who have equity in their property, it makes the most sense to use hard money loans as short-term financing, especially considering the high-interest payments required by most.

What are the Drawbacks? 

Hard money may be a simple solution, but it is not always a perfect or profitable one. Hard money loans have their drawbacks, including high interest rates and low loan-to-value (LTV) ratios. Hard money often entails double-digit interest rates of up to 15%, as opposed to the prime interest rate of 5.5%. Because the property is used as collateral, hard money loans typically yield an LTV ratio between 50-70%, while the LTV ratio for a standard mortgage is around 80%.

Real estate training programs offered through Real Estate Elevated explore numerous other options for project financing that might prove more beneficial than hard money loans.

Is a Hard Money Loan Right for Me?

For many house flippers and real estate investors in the search for fast funding, the pros of hard money loans can certainly outweigh the cons. By enabling you to get your work done without the hassle of conventional bank financing, hard money may be the right solution for you.

Are you looking to get a loan to flip your next house? There are several ways to get funding. To learn more, sign up for a free Real Estate Elevated Seminar.