Investment in real estate is something many people wish they could get involved in. However, because of its capital intensive nature, many do not go beyond wishing. Traditional mortgage loans are not the easiest to access so many fail to get the funds they need.
As an alternative to traditional lending, and an easier way to access loans for real estate investing, hard money lenders offer easier access to funding for people who would have otherwise been rejected by traditional lenders. While hard money in real estate is now an option being leveraged by many, it is not for everyone. You need to understand it so that you can use it to your best advantage.
In this article, we will be looking at the pros and cons of hard money loans so that you can have the information you need to make an informed decision.
What are Hard Money Loans?
Hard money or hard money loans are credit facilities offered by individuals, investment groups or other non-traditional lenders. The terms of these loans are often not based on credit scores or earning ability but on the value of the property that the loan is to finance.
This value, also referred to as After Renovation Value (ARV), is based on what the property is expected to be worth after it has been renovated and ready for sale. Also to be put into consideration is its prospects. So, if the property is in a good location and is likely to be quickly snapped up in the market, then you are almost certain of getting a hard money lender to provide the finance you need.
Pros and Cons of Hard Money Loans
Having explained what we mean by hard money, let’s now see the pros and cons of this type of loans. Knowing this will help you in your decision making process.
Pros
The following are some of the advantages of hard money loans:
- Less Stringent Criteria – Unlike traditional loans, the criteria for getting approved is less stringent. Once the ARV (After Renovation Value) of the property has been ascertained and its prospects confirmed, you are almost certain of being approved for the loan.
- Quick Processing of Application – Once you apply for this type of loan, the application is processed quickly and a response given. This is completely different from the process with traditional mortgage loans.
- Quick Funding – Once approved, the funds are disbursed quickly. This makes it possible for this type of loan to be used for investment opportunities that have to be concluded quickly.
- Available for Distressed Properties – Traditional lenders often reject loan applications for distressed properties because of the amount that will be required for its renovation. However, hard money lenders will offer these loans once the ARV is established. This makes it a good option for investors who engage in fix-and-flip deals.
- Flexible Loan Terms – Many hard money lenders will be open to arranging unique loan terms based on mutual negotiations. This is not possible with traditional lenders because the lending guidelines must be followed to the letter.
These are some of the obvious advantages that hard money loans offer.
Cons
Let’s now look at some disadvantages of hard money loans:
- Higher Interest Rates and Fees – The interest rates on this type of loans is higher than what you will get from traditional lenders. Generally, interest rates on hard money loans range from about 8% to 15%. In addition to this, you may also have other fees which could add another 2%, making it a lot more expensive than traditional loans.
- Shorter Repayment Term – The repayment term offered in hard money loans is usually between 6 to 24 months. This puts pressure on the investor to sell off the property or refinance it with a traditional loan to avoid going into default.
- Substantial Equity is Required – Hard money lenders almost never offer 100% of the financing required for a real estate purchase. The financing offered is often between 60% and 75% of the property’s ARV (After Renovation Value). This means you will need to contribute a sizeable chunk of the cost to complete the deal.
- Best for Short-Term Investments – This is not the type of loan you want to take for long-term real estate investments. This loan is best for short deals, like fix-and-flip deals or bridge financing.
- Risk of Foreclosure – Since the loan is directly tied to the property, any default means you risk losing the property to foreclosure.
When Is Hard Money Loan Ideal?
Having looked at the pros and cons of this type of loans, when should one go for them? Below are some ideal situations in which hard money loans will be idea:
- Short Term Projects – Short term property projects with a good chance of making quick sales are ideal for this type of financing. This makes it ideal for fix-and-flip deals once you can buy, rebuild and sell the property in good time.
- Bridge Loans – Hard money loans can be used when you need quick funds to help you conclude a project so you can refinance it through traditional lenders.
- Distressed Property Purchase – Traditional lenders may not avail you the funds you need to purchase distressed properties because of the cost of renovating it. This is a good place to use hard money loans, especially if you intend to quickly flip it.
- Auction Sales – When a building goes up for sale in an auction, you will not have the luxury to begin to look for traditional mortgage loans so going for a hard money loan can help you close the deal quickly.
Conclusion
Hard money loans can be of great help in the right type of investment opportunity. Knowing when to use it and when not to use it will be the difference between success and failure.
The information we have shared in this article will help you begin to have a better understanding of this credit facility so you can make the best use of it. Be sure to carefully consider your investment plans and goals, look at the numbers and be sure you know what you are doing before going for this loan.