Are Hard Money Loans Riskier than Other Types of Mortgages?
Hard money loans offer fast, flexible financing, but they also carry certain risks. Learn more about these risks and how borrowers can prepare themselves.
Hard money loans may work best for certain projects, especially when more traditional forms of financing are not available or would take a long time to obtain. The advantages of hard money lending over other types of loans include faster funding and greater flexibility. The risks involved with using a hard money lender aren’t so much about the loan terms themselves. Those should be spelled out to you clearly.
The risks exist around the integrity of the lender: with looser regulations, are they going to be transparent about their loan terms? Are they going to follow through with their commitments? Are they going to take advantage of a new borrower’s ignorance?
Read more: The Risks & Advantages of Hard Money Loans vs Conventional Financing
This article offers an overview of the risks involved in hard money lending, along with tips on how to protect your interests when looking for financing.
What are the risks of hard money lending?
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Hard money lenders are not subject to as many rules and regulations as other lenders. This can be an advantage when you are looking for flexible financing options. It could also be a disadvantage in some situations.
Big banks, credit unions, and mortgage companies must meet numerous legal requirements set by state and federal regulators, as well as semi-governmental entities like Fannie Mae and Freddie Mac. This type of financing, commonly known as “conventional” or “conforming”, might not be ideal if you need to move quickly to purchase a property. It can take several weeks or longer to get final approval and close on a conventional mortgage. Part of this delay is due to regulatory requirements intended to protect borrowers.
Hard money lenders are not subject to nearly as many regulations. While this offers the advantages of speed and flexibility, it also means that fewer legal protections are in place for borrowers. Hard money loans may not be subject to:
Limits on high interest rates
Minimum repayment terms
Maximum required down payments
Disclosure requirements about interest, loan terms, and other loan features
Borrowers must be extra careful about exercising due diligence when researching lenders for hard money loans. You should understand that a fast and flexible loan may come with a high interest rate and a short repayment term.
What could go wrong if you use a shady lender?
Predatory lending, meaning the use of deceptive tactics to lure borrowers in and impose abusive or unfair loan terms, is a problem in almost every part of the loan industry. Lenders of any size, from small private lenders to large banks, may engage in predatory lending practices.
Because hard money lenders are not subject to as many regulations as other lenders, borrowers must be vigilant about recognizing the possible signs of a scam. The consequences of doing business with a shady hard money lender could include losing money, losing the property you put up as collateral, and wasting valuable time.
Common signs that a lender is not being forthright with you may include the following:
Upfront fees: Most reputable hard money lenders will not charge you any upfront fees. Be wary of a lender who asks for a large fee at the beginning of the loan application process. They might call it a processing fee, or even a “due diligence” fee. In some cases, they might take the fee and then disappear altogether.
Read more: Be Wary of Upfront Fees to Hard Money Lenders
Undisclosed fees: Watch out for lenders that try to charge you hidden fees, or fees that they do not disclose to you in advance. The most common fees that hard money lenders charge are origination, inspection, and appraisal fees. Any other fees could be cause for concern.
Last-minute changes to the loan terms: A lender might make big promises about how they can provide flexible financing at a low cost and a low interest rate. Then, just before closing, they tell you that the fees and interest rate will actually be much higher. Hard money lenders who are on the level will tell you about high interest rates and other costs from the start.
No collateral required: The very definition of a hard money loan is its reliance on a hard asset to serve as collateral. Approach a hard money lender with caution if they say they do not require collateral.
Guarantee of full funding: As the saying goes, if something sounds too good to be true, it probably is. This includes lenders who say they can loan you 100% of a property’s appraised value. Hard money lenders typically require a loan-to-value ratio of at least 70%.
How can real estate investors protect themselves?
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Real estate investors can protect themselves from shady lenders in two main ways:
Know the signs of possible lending scams and other shady practices.
Carefully research prospective lenders.
The internet can provide a wealth of useful information about a hard money lender. Check with the Better Business Bureau and other consumer protection organizations to see if a lender has a good rating, or if it has been the subject of any complaints. Regulatory agencies like the Office of the Consumer Credit Commissioner or the Consumer Financial Protection Bureau may also have information about lenders.
If you can’t find any information about a lender online, that tells you something in itself. You want a hard money lender with experience and a good reputation.
Conclusion (a word of warning)
If you are a brand new real estate investor without any mentors, and you haven’t taken the time to research the credibility of a lender, using an unknown hard money lender (or any private lender for that matter) will be riskier than a conventional one. However, even if a conventional lender is forced into narrower lending parameters, they can still offer a disastrous personal finance decision for you.
We recommend you hold off on buying your first investment property until you can read and understand a closing sheet. Our “Hard Money and Private Lending Vocabulary” quick reference guide is a great place to start. Get familiar with those terms. We would love to get in touch and have a pressure-free conversation about what it takes to complete your first successful project.
Get in touch with a trusted hard money lender
Capstone Capital Partners sports over $500M in closed loans through our collective careers. We’ve served Texas investors since 2006. Our Google reviews, BBB reviews, and property portfolio speak for themselves. Speed, trust, and friendliness are paramount behind our success. Most of our business is composed of long-term, repeat borrowers.
Let’s talk about your project. Easily apply online with no strings attached.
