How Does a Hard Money Loan Work? A Beginner's Guide
Real estate finance can be difficult to navigate, especially when you are working on a tight timeline. In a competitive real estate market, a delay in financing could cost you your entire deal.
Traditional bank loans often take a long time to close and come with hurdles for qualification. They’re often designed with long repayment periods in mind. If you’re looking for a short-term loan for a real estate project, bank loans might not offer what you need.
A hard money lender can provide financing to you quickly, with fast turnaround times for both qualifying and closing on the loan. Here’s an overview of hard money lending.
What is a hard money loan?
A hard money loan is a short-term loan issued by a private individual or business - not a bank. They are most commonly used for real estate projects.
Why is it called a “hard” money loan?
Hard money loans use “hard” (or tangible) assets - usually physical property, like real estate - as collateral. When a borrower applies for a hard money loan, the lender focuses on the value of the borrower’s hard assets rather than the creditworthiness of the borrower.
This is one of the main features that distinguish hard money loans from more traditional types of financing. They are especially useful to people that cannot obtain a traditional real estate loan.
What is a hard money loan used for? Who uses them?
Hard money loans are popular among real estate developers, builders, and house flippers who are looking to finance a project.
The borrower secures funding for their project from the hard money lender and often sells the property within a couple years. Then the borrower pays off the hard money loan. Hard money loans are often essential when someone needs fast approval and funding.
How is a hard money loan different from a conventional mortgage?
Because hard money lenders are not banks, they are not subject to most of the regulations from laws like the Dodd-Frank Act and the Truth-in-Lending Act. This allows them to be more flexible in their guidelines for loans and to issue loans faster. It also means that they take on greater risk than banks do with traditional loans. This additional risk is reflected in shorter repayment periods, higher interest rates, and lower loan-to-value (LTV) ratios.
Banks rely on factors like credit history, debt-to-income ratio, and assets when evaluating a loan application. Hard money lenders focus on the value of the property offered as collateral. If a borrower fails to repay a hard money loan, the lender can take title to the property.
Hard and soft money loans also differ with regard to how loans are funded. Banks are able to issue mortgage loans and other types of real estate financing by using their own resources and by selling mortgages to entities like Fannie Mae. Hard money lenders obtain money from other private parties for whom hard money loans are a type of investment.
How does a hard money loan work?
What are the steps toward getting a hard money loan? Since hard money lenders are not subject to all of the laws and regulations that govern banks, they can be fairly flexible about their procedures. In other words, each hard money lender’s process may vary since they establish their own rules. But these basics elements will be present:
Step #1: Appraisal - Since hard money loans are backed by hard assets like real estate, you will need an up-to-date appraisal of the property.
Step #2: Application - The loan application will ask for information about you, the property, and the project. Lenders want to know how much the property is worth, how much it could be worth when you complete the project, and your level of experience in real estate.
Step #3: Review and approval - The lender will review the application and make a decision. Unlike bank financing, this could take less than 24 hours.
Step #4: Closing and funding - This also occurs faster than with soft money financing, usually within about a week.
Step #5: Repayment - You will be responsible for making periodic payments of principal and interest. Since the repayment period is much shorter than with other loans, there will be a balloon payment at the end. Ideally, you are able to complete your project and either sell it or obtain long-term financing, which you can use to repay the hard money loan.
Types of hard money loans
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Hard money lenders offer loans tailored to different types of real estate projects, including:
Fix and Flip: Hard money loans can close much faster than other types of renovation loans. This is ideal for many house-flipping projects.
Commercial Bridge: This type of loan helps when you need money to cover your project until you can either complete and sell the property or close on long-term financing.
Renovation: A hard money loan can provide exactly what you need to complete a renovation project, producing high return on investments.
Rental Properties: Whether you are developing and building a rental property or renovating an existing one, a hard money loan can provide the money you need to see you through the project. This can apply to single-family or multifamily rental properties.
What are the big benefits of using a hard money loan?
The main advantages of hard money loans are:
Speed of approval and funding
Flexibility in requirements and terms
Hard money loans have short repayment terms, usually no longer than one to two years. This often makes hard money lending ideal for construction and renovation.
Potential cautions on hard money loans
Since most of the laws that regulate banks do not apply to hard money lenders, borrowers should be cautious when considering which lender to approach. Experience, reputation, and transparency are critically-important factors.
While flexible qualification guidelines are super advantageous, the unregulated nature of private hard money lenders can pose risks as well.
What to look for when choosing a hard money lender
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Features to look for when considering a hard money lender include:
Local: Knows the community where the real estate and project are located. Which projects have they completed in the area? What were their outcomes? Do they personally hold any investments or properties in the area? Are they knowledgeable about recent news surrounding local real estate?
Experienced: Has a proven track record in the field. How much has the lender funded? Are their borrowers and investors generally happy with their outcomes? Do they make solid guarantees on loan terms?
Reputable: Has the respect of real estate investors, developers, builders, and other professionals. They should also have online reviews, testimonials, and information on their portfolio.
Honest: Discloses all fees from the start and is transparent about the lending process. If the lender is shaky in the beginning about loan terms and timelines, it’s usually best to trust your gut and find a different lender.
Read more: Meet the Executive Team at Capstone Capital Partners
Get in touch with hard money lenders you can trust
Hard money lending with Capstone Capital Partners provides fast and flexible financing for real estate projects in Texas and beyond. Borrowers can expect friendly service from beginning to end. Get started on your free pre-approval now.
