Most people have a fair understanding of traditional bank loans and how they work. Whether you’re looking to buy a home or an automobile, you can approach a lender, submit to a credit check, and gain approval for lending relatively quickly and with little fuss.
Fewer people know what hard money loans are or how they work. However, they may be a viable and even preferable alternative for certain borrowers or certain property purchases. Here are a few basics on hard money lending – what it is, how it started, and how it can benefit you.
What is Hard Money Lending?
There are many differences between traditional bank loans and hard money loans, but perhaps the biggest is where the money comes from. With a traditional loan, the money comes from lending institutions like your local bank that work with pooled funds to offer loans.
Hard money lending, on the other hand, relies on money from private lending sources, sometimes from a single investor and sometimes from several investors’ pooled funds (fractionalized loans). In addition, the collateral for a traditional loan is usually the property being purchased, most often a single-family residence. Hard money loans are more often used for unconventional property purchases, such as rental units, just for example.
Hard money loans are usually handled by specialized brokers called private money lenders, rather than traditional loan officers employed by banks. One final point to consider is that hard money loans tend to feature higher interest rates (8% and up), generally due to a smaller lending pool and increased risk factors.
How Did This Type of Lending Start?
Hard money loans are most common in the U.S. and Canada. This form of lending came into existence during the credit industry overhaul of the late 1950s when it became more difficult for certain borrowers and property purchasers to obtain traditional loans.
Real estate crashes in the ’80s and ’90s were particularly detrimental for hard money lenders due to properties funded over their values. Hard money lending is based on loan-to-value (LTV) ratios, whereby lenders determine what they could reasonably sell a property for if the owner defaults.
It usually comes out to about 60-70% of the fair market value at the time the loan is approved. This is the maximum amount of cash most hard money lenders are willing to offer. Following the market crashes, policies for hard money lending changed, driving down LTVs to increase market stability and increasing interest rates to account for higher risk in lending.
Who Should Consider Hard Money Loans?
Hard money loans are ideal for a variety of borrowers that are not good candidates for traditional loans, such as those who are self-employed or have other non-traditional sources of income. Hard money loans may also be more easily obtained by borrowers that have had credit issues in the past, although there is no guarantee that someone with a poor credit score will be issued a loan.
What Types of Property Can You Buy with Hard Money Loans?
Unconventional property purchases are the bread and butter of the hard money lending industry. Whether you’re interested in non-owner occupied rental units, mixed-use properties, land purchases, or even rehab loans, hard money lenders may offer funding when traditional lenders turn you down.