What is a hard money loan and how does it work?

A hard money loan refers to a type of loan. However, what sets it apart from other types of loans is that it is secured by real estate. In addition, short-term bridging or last-resort loans are considered. Basically, they are used in different real estate transactions. Lenders are companies or individuals, not banks. Keep reading to know more.

key takeaways

Below are some of the salient features of these loans.

  • Mainly, they are used for real estate transactions. And this money comes from a company or individual instead of a bank.
  • Usually, this type of loan is granted for a short period of time. The purpose is to collect money quickly at a lower LTV ration and higher cost.
  • Since these loans are not traditionally executed, the funding time that is reduced is usually quite fast.
  • It is interesting to note that the terms of these loans are negotiated between the borrower and the lender. Also, these loans use real estate as collateral.
  • Although the repayment may result in default, they still leave a large amount of profit for the lender.

How does a hard money loan work?

Generally, the terms of hard money loans are based on the value of the real estate, not the creditworthiness of the borrower. Since conventional lenders like banks are not the lenders, private lenders or companies are more interested in this business.

Also, these loans can be a good option for property buyers who have plans to renovate a property and sell it again. Here you may be thinking that the cost of this type of loan is quite high. But the good thing is that the additional cost is offset by the loan that will be paid off fairly quickly. In most cases, the loan is granted for a period of 1 to 3 years. Apart from this, they also offer many advantages.

Apart from this, this type of loan is also considered a great investment. You can find many people who have done this business and are happy with the practice.

Special Considerations

In general, unlike bank financing or financing programs offered by the government, the cost of these loans is much higher for a typical buyer. However, this cost reflects the increased risk assumed by the lender. But the good thing is that the extra cost is worth it since the money is readily available. The approval process is less strict, and the repayment schedule is also quite flexible.

Also, these loans can be a great option to deal with changing situations. For example, if you need money quickly for short-term financing but have a low credit score, you might want to give it a try. Since the amount is issued fairly quickly, you can use the funds to avoid foreclosure, for example.

Pros and cons

Now, let’s take a look at some of the pros and cons of hard money loans.

advantage

First of all, the approval process is much faster than the mortgage process or a conventional loan. What happens is that private lenders are interested in this type of business, since they can make decisions quickly without having to do many checks. In other words, they won’t check your credit history. These are the steps that slow down the process and make the borrower wait weeks.

Typically, these investors only care about redemptions. In addition, they have the opportunity to resell the property in case the borrower defaults and becomes delinquent.

Another advantage is that lenders do not apply the conventional underwriting process. Instead, they evaluate all cases one by one. Often applicants can sit down with the lender and discuss the payment schedule based on their circumstances. Apart from this, the borrowers can take advantage of many opportunities during the time they have. So this is another great advantage that you can enjoy if you go for this option.

cons

Since real estate is used as collateral against default, these loans come with lower LTV rations unlike regular loans. This ration is between 50 and 70%, unlike the ration of regular loans, which is 80%. However, if you are an experienced pinball player, it can be even higher.

Apart from this, the interest rates on these loans are also higher. For subprime loans, the interest rate can be even higher. In 2019, for example, hard money loan rates were between 7.5 and 15% depending on the period of the loan. On the contrary, the prime interest rate was only 5.25% in the same period.

Another disadvantage is that these lenders may not offer loans against owner-occupied properties due to compliance standards and regulatory oversight.

I hope you now understand what hard money loans are and the pros and cons associated with them. For more information, you can consult your mortgage broker.

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