What is a Hard Money Loan and When is it Used?
Remember growing up and hearing the term “cold hard cash” and knowing it meant cash. The same can almost be said for hard money loans. While they’ may be loans, they are generally used as cash transactions. Learn more about hard money loans and when they’re used.
What is a Hard Money Loan?
A hard money loan is a short-term loan typically used to purchase real estate property. They generally last for about a year but may go up to five years. Unlike conventional mortgage loans that have principal and interest payments, hard money loans are interest-only loans. When the borrower takes out the money, he or she only pays interest for the life of the loan.
At the end of the loan, the entire balance is paid in full. The interest rates on hard money loans is generally higher than on regular loans because they are short-term loans. Hard money loans are different from conventional loans in many ways. One of the biggest ways they differ is that hard money loans do not have all the requirements as conventional mortgage loans.
When you apply for a conventional mortgage loan, you need to show the bank that you have sufficient income, steady employment and good credit. Hard money loans are not based on this criteria. They are based on the value of the real estate because if you default on the loan, they can just repossess the property.
Another area where hard money loans are different is in who provides the financing. The money for hard money loans typically comes from investors or investment firms as opposed to banks and lending institutions.
Because they are short-term loan and real estate-based, it’s not unusual for a borrower to have more than one short-term loan in place at one time. This is one advantage they have over regular loans. With a regular loan, the lender probably would deny a second loan because of the borrower’s debt-to-income ratio. This is not the case the hard money loans.
When is a Hard Money Loan Used?
Hard money loans are used when the borrower needs a short-term loan. A good example would be a fix-and-flip investor. This individual may go to a real estate auction and purchase property. He or she will need the money immediately to purchase the property. The borrower will renovate the property, sell it and pay off the hard money loan.
Hard money loans may also be used in construction loans. The borrower will take out a hard money loan for the amount needed to build the property. While the property is being built, the borrower makes interest payments. When the property is complete, the borrower generally refinances with a conventional mortgage loan,
Benefits of Hard Money Loans
Although hard money loans typically come with higher interest rates and shorter loan terms, which many borrowers frown on, there are still several benefits of hard money loans.
• Approval – This is probably the biggest benefit of hard money loans. Applying for a conventional mortgage loan can often take weeks from the time the borrower first applies for the loan. The lender must verify all the documentation like employment, income, credit, etc. With hard money loans, all that documentation is not required. While hard money loans may require some paperwork, it’s minimal compared to what’s required with conventional mortgage loans. The lender is generally basing the decision on the value of the property and the borrower’s equity. Therefore, hard money loans can often be approved in a day or two.
• Fewer Requirements – As stated above, hard money loans do not require near the paperwork or the credit scores required with conventional loans. With a hard money loan about all you’ll need to show is that the real estate is worth what you’re requesting and that you can put up at least 20 percent deposit or down payment. The percentage may vary from one investor to another.
• Credit Not an Issue – Your credit scores play a large part in determining if you get a mortgage loan from a lending institution. When you apply for a hard money loan, they may or may not even check your credit. If they do check it, it may not even play a part in their approval. The value of the real estate is what’s important here.
• Flexibility in Payments – When you’re dealing with a financial institution for your mortgage, they pretty much determine your loan term and the payment amounts. With private lenders and investors, you’re in a better position to discuss payment options, and the investors are usually willing to work out a repayment plan that satisfies everyone involved.
• No Prepayment Penalties – If you happen to have some extra cash, you can pay the hard money loan off without getting charged a penalty. This is not always the case with conventional loans.
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