What are Hard Money Loans?

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A hard money loan is a type of financing commonly used in real estate transactions, where the loan is secured by the property itself rather than the borrower’s creditworthiness. Offered primarily by private lenders, these short-term, high-interest loans are a go-to for real estate projects like fix-and-flips and construction. While they offer quick access to capital, they come with higher costs, making them a strategic but expensive financing option.

Candidates for hard money loans

Hard money loans are often the vehicle of last resort, made to consumers who are unable to get adequate financing from conventional lenders like banks, credit unions, and traditional mortgage companies.

Hard money loans typically attract borrowers who fall into one or more of the following categories:

Borrowers with credit challenges:

  • Low credit scores: Individuals with bad credit or recent bankruptcies who wouldn’t qualify for conventional loans due to their credit history might turn to hard money.
  • High debt-to-income ratio: Borrowers with significant existing debt may struggle to get traditional financing, making hard money a potential option.

Borrowers with unique property needs:

  • Unconventional properties: Hard money often finances properties that fall outside the standard criteria for traditional lenders, such as log cabins in remote areas, investment properties with unusual features, or fixer-uppers.
  • Non-conforming properties: Properties that don’t meet FHA or VA loan requirements due to zoning restrictions, structural issues, or other reasons might be financed with hard money.

Borrowers needing fast access to capital:

  • Time-sensitive situations: Developers requiring immediate funding for projects, distressed homeowners facing foreclosure deadlines, or investors seizing time-sensitive opportunities may utilize hard money due to its quick closing times.
  • Bridge financing: Hard money loans can act as a temporary bridge until the borrower secures permanent financing, such as refinancing after credit improvement.

Other potential borrowers:

  • Real estate investors: Hard money is commonly used by property flippers who buy, renovate, and sell properties within a short timeframe.
  • Business owners: Businesses with limited access to traditional loans due to their size or industry might use hard money for expansion or other projects.
  • Individuals facing financial distress: In rare cases, borrowers facing urgent financial situations like medical emergencies might explore hard money as a last resort.

It’s important to note that hard money loans are not a one-size-fits-all solution. Due to their higher costs and risks, they should only be considered after carefully evaluating all available options and understanding the potential consequences. Seeking financial counseling or advice from experienced professionals is crucial before embarking on a hard money loan journey.

Scenarios for hard money loans

Here are some typical examples of situations that might require a hard money loan:

  • You want to buy a log cabin on a remote tract of wilderness land in Alaska. Most lenders are reluctant to lend money to purchase property in a distant, isolated location, especially if the land is more valuable than the house. In the event of foreclosure, this kind of property could be too difficult for the mortgage company to sell. A private investor, however, might lend you the money as a hard loan.
  • A rancher needs a mortgage to buy a neighbor’s prairie acreage for grazing cattle, but it’s difficult to determine the land’s value by conventional appraisal methods. A retired railroad worker decides to buy antique cabooses and convert them into guesthouses in a tourist destination, but the style of housing is so unusual that conventional lenders can’t traditionally appraise it. Hard money loans might be the answer in either of these circumstances.
  • You have bad credit, a recent bankruptcy, or want to borrow more than you qualify for with a mainstream lender. Conventional lenders will likely turn you down because you represent a high risk for default. But hard money lenders may accept that kind of risk, especially when the underlying collateral is valuable.
  • A developer wants to borrow $3 million to buy a factory that closed down, in order to convert the space into upscale condos. He’s ready to begin construction, but he’s already borrowed money for another building project, essentially tapping all his currently available credit. With a hard money loan, he can get the funds immediately. Paying extra interest is worth it for him so he doesn’t have to delay his new venture.

Rules of convention

Mainstream lenders turn down loans to people with poor credit or unusual, quirky properties because they must adhere to strict industry guidelines, such as those outlined by Fannie Mae. 

The specific rules and sets of criteria are followed in order to reassure investors who buy the loans in secondary markets. The government supports this kind of reselling of loans, because it helps ensure that there’ll always be plenty of investor money available to Americans who need to buy homes with mortgage loans. Fannie Mae, for its part, bundles together mortgages and then issues “mortgage backed securities” based on the total value of the loans in each bundle. These securities-which are traded much like stocks-can then be conveniently sold to investors around the world. In order to keep this kind of market working smoothly, the investors need to be confident that the loans they represent are solid and risk-free. As a result, the government sets strict lending guidelines.

Rules of hard money

Hard money lenders make up their own rules based on the level of risk that they’re comfortable with, and their own experience in the business. Because their portfolios of loans are much harder to sell to other investors, hard money lenders can’t rely on making money through secondary markets in the way that Fannie Mae does. Instead, they have to generate their own profits by charging higher interest rates to the borrower.

In distressed situations, such as bankruptcy or imminent foreclosure, hard money loans may be the only way for a homeowner to avoid a catastrophe. Of course, when consumers are under duress, they may be exposed to unscrupulous, predatory lending schemes. Gangster movies depict predatory lending to people with gambling debts or financial troubles. While Hollywood portrays extreme, illegal lending practices, the vast majority of hard money lenders aren’t loan sharks at all. Instead, they occupy a perfectly respectable and important niche within the mortgage lending sector.

Despite costing more and being less popular than conventional mortgages, hard money loans can be invaluable to consumers who need them. In fact, without hard loans, many consumers would be stuck in financial catastrophes with no way out, or would have to pass up lucrative business opportunities because they lack funds.

How to find a hard money lender

Finding a hard money lender may require additional research, because they’re not nearly as numerous as conventional lenders. Many only lend money in their immediate geographic areas in order to personally visit properties before making dangerous loans.

Here are some common places to start when searching for a hard money lender:

  • Mortgage brokers: Many brokers deal with hard money lenders and can connect you with suitable options based on your needs.
  • Real estate investors’ associations: Local REIA groups often have networks of hard money lenders they recommend.
  • Online directories: Websites like BiggerPockets and LendNation compile lists of hard money lenders by state or region.
  • Reviews and ratings: Check online reviews and ratings on platforms like Google Reviews and BBB to get insights on lender reputation and past client experiences.

When vetting potential lenders, verify their credentials, compare loan terms and fees, ask plenty of questions, and thoroughly review the loan agreement, ideally with an attorney, before signing. Remember, prioritize working with a reputable lender who respects your questions and offers transparent terms. By investing time and effort in your search, you can confidently navigate the hard money loan landscape and find the right partner for your financial needs.

Aaron Crowe

Aaron Crowe is a seasoned personal finance and real estate journalist. Aaron writes on real estate as it relates to mortgages, refinancing loans and lending for Refi.com.

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