A real estate investor’s best friend is hard money loans. As trite as it may sound, the statement holds true. For real estate investors wishing to complement their investment deals, these loans provide a steady supply of income.
Whether an investor needs to rapidly close on an undervalued property or fix it up for a potential buyer, a hard money loan is a crucial tool to have in one’s toolbox. Hard money loans, like any other type of loan, come with fees. Understanding them is crucial to maximizing a real estate investor’s most valuable capital stream. This article will break down hard money loans and their potential interest rates.
What are Hard Money Loans?
A hard money loan is a secured loan backed by real estate. Hard money loans are often known as “loans of last resort” or “bridge loans.” These loans are typically employed in real estate transactions, and the lenders are usually individuals or businesses rather than banks. Overall, a hard money loan is a short-term loan that allows you to raise money rapidly at a greater cost and with a lower LTV ratio. The funding time frame for hard money loans is shorter because they rely on collateral rather than the applicant’s financial situation. Hard money loan terms are frequently negotiable between the lender and the borrower. The most common kind of collateral for these loans is real estate.
The terms of hard money loans are primarily determined by the value of the property used as collateral, rather than the borrower’s creditworthiness. Hard money lenders are frequently private individuals or companies who find value in this type of potentially dangerous undertaking since regular lenders, such as banks, do not issue hard money loans. Property flippers may seek hard money loans if they intend to refurbish and resell the real estate used as security for the loan within a year, if not sooner. The increased cost of a hard money loan is countered by the borrower’s intention to pay it off quickly—most hard money loans are for one to three years—and some of the additional benefits they provide.
Requirements for Hard Money Loans
- Borrower qualification
While some lenders are asset-based, the majority of them are also concerned with how the borrower appears on paper. The borrower’s liquid reserves and creditworthiness are two key markers of how likely they are to repay the loan on time. Now, the particular factors used by lenders to determine the amount of money required in the bank or a specific credit score vary per lender, so it’s critical to be aware of this early on in the process.
- A worthwhile deal
Lenders in this group are business people that want to make the most money possible with each loan they make. The lender and the borrower are on the same page because the lender wants the borrower to succeed so that they can make money and repay the loan on time. The lender will initially check to see if the borrower meets the conditions they’ve set. After they will evaluate the contract to see if it’s feasible before approving the loan request. In other words, once the lender is convinced that the property and agreement make sense, the odds of getting authorized increase.
If you’re thinking about taking out a hard money loan, make sure to calculate the profit margin by comparing the property’s worth to the repair expenditures. Be sure the profit margin is big enough to not only pay off the loan but also make a profit, whether from pure profit from selling to an end buyer or cash flow from renting.
- Down payments
Although not all lenders demand a down payment, many do. Yes, the loan will cover the majority of the buying price but the down payment demonstrates your dedication to the project. It also aids the lender in risk mitigation. After all, they are putting a lot of money into the project, so it’s only right that the investor shares in the risk by putting some of their own money into it as well. Oftentimes the lender will require some type of collateral, such as origination points, admin fees, doc fees, and other such conditions.
Hard Money Loan Rates
The procedures and paperwork of hard money loans are frequently less severe than those of a traditional loan. Hard money loan rates are clear within days rather than weeks, and they can infuse more money into a transaction, requiring the borrower to put less money down. While this is one of the most appealing features of hard money loans, it is also one of their disadvantages. Granting loans with fewer underwriting standards and investing more money on a deal exposes the lender to greater risk.
As a result, in order to offset the risks, higher interest rates are imposed. Although these rates fluctuate, the average hard money loan interest rate according to Bankrate is 11-13%. These interest rates do vary, depending on the lender it may be anywhere between 6% to 15% annually.
The interest rates on hard money loans can be decreased by:
- Improve Your Personal Credit: Financial literacy is measured by a good credit score. Improve your credit score months before you apply so the lender may be confident there will be no defaults.
- With a hard money lender, complete and pay off various loans: To aim for less risk, the better track record one has with the lender, the more open-minded they will be to reducing the interest rate or original fee.
- Increase Your Down Payment: When a lender supports a transaction at a lower Loan to Value Ratio, a down payment helps the lender lessen the risks involved with giving out loans to individuals (LTV). Increasing the down payment shows that the borrower is serious about the project and will be less likely to default.
Pros and Cons of Hard Money Loans
Pros: When compared to applying for a mortgage or other traditional loan through a bank, the approval procedure is typically a lot faster. Since the lender is focused on collateral rather than an applicant’s financial situation, the private investors who fund the hard money loan can make decisions faster. For example, lenders will spend less time looking at a loan application to verify income and review financial documents. The process will be significantly easier if the borrower already has a relationship with the lender.
If the borrower defaults, hard loan investors may have a better value and opportunity to resell the property themselves, thus they are also less concerned about receiving payment.
Cons: Hard money loans often have lower LTV ratios than standard loans, ranging from 50 to 70 percent (vs. 80 percent for regular mortgages), because the property itself serves as the only guarantee against default. Keep in mind it can go higher if the borrower is an experienced flipper.
In addition, interest rates are typically high. The interest rates for hard money loans can be considerably higher than those on subprime loans. The average interest rate for a hard money loan in the United States is 11.25 percent, with prices ranging from 7.5 percent to 15 percent.
The last disadvantage is that, due to regulatory scrutiny and compliance restrictions, hard loan lenders may refuse to offer finance for an owner-occupied property.
Danis Woods in Businessman, investment banker and stock exchange traders. On the same time he loves writing financial blogs to shed lights on different aspects that new and existing businessman are not aware of.