The Risks of Using Hard Money Loans vs. Mortgages
Hard money loans offer many advantages, but also some drawbacks. Learn more about when a hard money loan would be right for you, and when it wouldn’t.
Hard money lending offers many advantages over more traditional bank loans. When do the advantages outweigh the drawbacks? Who would benefit the most from hard money lending’s advantages?
If you are looking to finance a real estate project but you’re not sure if a hard money loan is something you should pursue, here are some considerations to think about.
Pros of hard money loans
The advantages of hard money loans over regular bank loans mostly derive from the fact that hard money lenders are not banks, so they’re not restricted by nearly as many rules and regulations. This allows them to operate with much more flexibility.
Quick approval and closing
The approval process for bank loans can take quite some time as loan officers and underwriters must conduct a thorough review of prospective borrowers’ loan applications and all supporting materials. Once you have filed a loan application, you may wait weeks or even months for a decision to be made. Hard money lenders are able to review applications and make decisions much faster. Sometimes, approval can come in as fast as twenty-four hours.
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From application to approval - and approval to funding - hard money loans should close faster than traditional bank loans.
The fast turnaround of hard money lending helps you secure a competitive deal when time is of the essence. You can be assured that you will not have to wait long for an answer, or for funding.
Less emphasis on credit history
Banks take risks on borrowers. Hard money lenders take risks on property.
A bank will scrutinize a loan applicant’s financial history, including their credit score, employment, income, and assets. They want to know if it is worth taking a risk that this person will not repay the loan. Hard money lenders, on the other hand, look most closely at the value of the collateral that the borrower is offering. If the borrower defaults, they want to be sure that the property will cover the amount of the loan.
If you or your company does not have a strong credit history, a hard money loan may very well be your best choice. A hard money lender might still take a look at your credit, but if you can present them with valuable collateral, your credit might not be the deal-breaker as it would be for a bank.
Flexibility
Bank loans tend to color within some well-defined lines. They offer certain types of loans with little variety from one borrower to another. This is largely due to the rather extensive banking laws and regulations that protect borrowers from unscrupulous lending activities.
Hard money lenders are not subject to most of those laws and regulations. This allows them to work with borrowers to create more customized loans for specific real estate projects. A house flipper does not need the same kind of loan as a builder. Hard money lenders can operate with enough flexibility to meet different borrowers’ unique needs.
Cons of Hard Money Loans
The flip side of a less-regulated environment is that hard money lenders take on much greater risk when they loan money to someone. The main disadvantages of hard money loans stem from hard money lenders’ efforts to mitigate that risk.
Higher Interest Rates
In addition to a different lending criteria in which credit score isn’t a heavy factor, borrowers often seek hard money loans for projects involving distressed properties that banks don’t want to touch. Since hard money lenders take on greater risk than banks, they charge higher interest rates.
Larger Down Payments
While this is not always the case, hard money lenders often require relatively large down payments from borrowers. This is also a way for them to manage the greater risks they take when lending.
Shorter Repayment Periods
Hard money loans are often used for short-term financing, such as when a house flipper plans to sell a property after repairing and improving it, or when a builder needs money while they are waiting on longer-term financing. Borrowers should expect a short loan term, usually no longer than a year or two.
Higher Monthly Payments
A shorter repayment period means higher monthly payments. One advantage of a typical 15- or 30-year mortgage is a lower monthly payment. A hard money loan is likely to have a much higher monthly payment because you’re expected to repay it within around three years’ time at the most. A hard money loan may also have a balloon payment at the end.
When it might be better to hold off on getting a hard money loan
Suppose you have a real estate project and you’re looking for funding. When might it not be a good time for you to apply for a hard money loan?
More traditional financing is available to you: For a first-time house-flipper, traditional financing may seem a little more comfortable if short term loan payments feel intimidating. But when banks are not an option because of the borrower’s credit or the current condition of the real estate, hard money loans could be a great option.
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You don’t have a timely exit plan: A hard money loan works best when your business plan includes a way for you to pay the loan off in a short time frame. As described above, this might involve selling a house after renovating it,or closing on a longer-term loan when you are further along on the project. If you don’t have a plan for how to do that, a hard money loan might not be the right choice for you.
Find out more.
Capstone Capital Partners offers fast and flexible hard money loans for real estate projects in Texas and beyond. You can expect friendly service from beginning to end. Applying is easy - answer a few quick questions about your project to find out exactly what you qualify for!
