Who doesn’t love watching a show where someone flips a home? The satisfaction of watching an old and rundown home transform into a gorgeous house with an increased home value is enlightening.
What most people don’t talk about is the financing aspect of fixing up a home. That is where hard money loans shine. Most real estate investors use these loans to access the capital they need to complete their renovation project and get the house back out on the market.
If you are interested in starting a home project but don’t know where to start, you came to the right place. Read on for an article that will go over hard money loans and who you can reach out to for more information.
What Are Hard Money Loans?
Hard money loans differ significantly from any traditional type of loan. The main difference between the two is that hard money loans are often used for fix and flip projects instead of buying a house to use as a primary residence.
Hard money loans, also known as bridge loans or rehab loans, are always backed by a “hard” asset. This asset, typically the property in question, is used as collateral.
How to Get a Hard Money Loan
If you are looking to apply for a hard money loan, you will need to reach out to a private lender. Most traditional banks and lenders do not offer hard money loans because of the risks behind the loan.
They also do not release hard money loans because those loan options do not have the same regulations as a conventional or federally backed loan. When you apply for a loan through a private lender, make sure you do your research on the company before you apply.
A few predatory lenders may give you unfair loan terms that will keep you in debt. Once you find your hard money lender, you will submit an application either in person or on their website.
Finding a Lender
When you find a lender, make sure that you do your due diligence and look into the company before you apply. This means checking out their reviews, ensuring they have a good reputation, and reviewing their accreditations.
You will also want to ask a lot of questions during the application process. Ask the lender about any extension or pre-payment fees that they may have.
You will also want to make sure you look out for red flags.
If the process feels sketchy or the lender dodges any of your questions, you should probably look elsewhere. If someone tries to charge you an application fee, do not pay that—no reputable lender charges to apply for a loan.
Hard Money Interest Rates
Interest rates on hard money loans are typically a lot higher than any traditional mortgage loan.
The average interest rate for most 30-year fixed mortgages is around 2.7% APR in 2021, whereas for a hard money loan it can be about 7% to 15%. It is imperative that you do your research and shop around before deciding on a hard money lender.
Terms of Hard Money Loans
Most of these loans have shorter terms, typically 12 months. The average term for this loan is usually no more than 24 months.
There are a few lenders who only give you around eight to ten months to repay the loan. These loans are so short because the lender expects you to fix and flip the home within a short amount of time so you can repay the loan quicker.
Hard Money Loan Qualifications
Many real estate investors prefer to use hard money loans because of the ease of application. Hard money lenders are more concerned with the value of the property instead of the borrower’s creditworthiness.
The lender will want to ensure that the property is worth what you claim it is and that you have the proper equity in the property. Lenders will also want to look at your portfolio.
If you have a decent portfolio showing that you have experience buying and selling properties, you will have an easier time receiving an approval.
Those without a lush portfolio may have a more challenging time receiving an approval, but that does not mean that it is impossible. There are hard money lenders willing to work with those who do not have as much experience as other investors.
Do I Need a Down Payment?
You do need a down payment for a hard money loan. The down payment for this type of loan is significantly higher than a down payment for a conventional loan or a government-backed loan.
Those down payments range from around 3.5% to 10%. Hard money loan down payments are usually about 10% to 20%.
Some lenders even ask for approximately 50%, depending on your situation and the loan amount you want to have. A lot of hard money lenders lend to those with lower credit scores. To help minimize their risk, they will ask for a higher down payment.
Why Is It Called a Hard Money Loan?
Hard money loans have their names because they are backed by a “hard” asset such as a house or some other type of real estate property. If the borrower defaults on the loan, the lender takes over the title of the home to satisfy the debt of the borrower.
Hard Money Loan Advantages
One of the most significant advantages of securing a hard money loan is that you do not need excellent credit. As mentioned earlier, lenders release these loans to those who don’t have great credit because they are more interested in the property’s value.
If you are looking to rehab a property, ensure that the amount of money you wish to request is realistic enough to cover the entire project. You also want to ensure that the home will sell soon, so you aren’t stuck paying a high monthly payment to the lender while the house sits idly.
Quick Closing Process
Unlike traditional home loans, you can close within weeks or even within a couple of days with a hard money loan. Most traditional lenders want to take a good look at your overall financial health.
This includes your income, assets or debts, credit scores, and employment history. That entire process can take weeks or even months to finish up. Hard money lenders allow you to close on the loan a lot sooner, sometimes within the same day!
As stated earlier, hard money loans have shorter repayment terms. Skilled house flippers only need the funds for the renovation, and they then sell the home quickly.
Depending on who you choose as your lender, if you need more time, they can extend the repayment time on your loan.
Make sure that you read over your contract to see if you have that option before signing anything. You may have to pay an extension fee to extend the loan, but this depends on your lender and the terms of your loan.
Hard Money Loan Disadvantages
Although there are many significant advantages to obtaining a hard money loan, there are a few disadvantages you will need to keep in mind—for example, the interest rate.
As we mentioned above, hard money loans have higher interest rates due to these lenders’ risk. Although this may seem like a significant disadvantage, you have to remember the risk these lenders take on by providing you with such a large loan.
Furthermore, hard mony loans are typically interest only. This means that you will only be paying the interest every month so the payment may not be as high as you originally think. This does however, leave a balloon payment at the end of the term. Your goal is to sell or refinance before this payment is due.
Typically, hard money lenders do not charge pre-payment fees for bridge loans. They would prefer you to sell or refinance the property and compelte a successful project rather than draw out the process. It also means you can get on with your new project quicker.
Having said that, here is some additional information on other scenarios. There are some lenders who penalize you for paying late on your loan, and there are others who will penalize you for paying early on your loan. Although that may sound odd, there is a reason behind why some lenders charge you for paying early on the loan.
Lenders charge you for paying ahead of time because they lose out on the profits they would have earned from your monthly interest rates. For example, say that your loan term is six months.
The lender will expect you to hold out on the loan for about four months so they can gain profits from your interest rate.
When you repay it before that set time, you deny them those profits, so they will impose a pre-payment penalty fee to ensure that you do not pay ahead of time. This practice is typically more prevalent with long term rental loans than bridge loans.
Make sure that you read over your contract or ask your lender about repaying the loan early.
You May Lose the Property
If you do not sell the home within a specific time or you stop paying on the home loan, the lender will take back the home. To recoup their loss, they will then sell the house. Make sure that you always make your payments on time and finish your home improvement projects within your schedule.
Traditional Loans vs. Hard Money Loans
There are many different factors at play when you apply for a traditional loan. As stated earlier, these types of lenders look into your credit score and other parts of your financial aspects to deem you worthy of having them approve you for a loan.
The other reason why banks and credit unions do not release hard money loans is because of their own restrictions. For example, a traditional lender may only authorize an FHA or a conventional loan because these loans fall within specific parameters and have certain backings by the government or Fannie Mae.
This means that an FHA or traditional loan may not be used for a fix and flip loan project because of certain restrictions. To elaborate further, let’s look at government-backed loans. These loans are FHA loans, USDA loans, or VA loans.
Each loan has its own set of requirements, such as how much you can take out for each loan and the types of properties you can purchase with them. FHA loans are for primary residences, and you are only allowed to take out a certain amount of money set out by the government.
They also require inspections to prove that the home is “move-in ready.” Homes that need rehabbing are not move-in ready; therefore, they would not qualify. Hard money loans do not have set requirements or stringent underwriting processes.
How to Get a Better Rate
If you are interested in getting a hard money loan but are concerned about the interest rate, you can do a few things. You can increase your down payment, so you have a lower loan to value ratio (LTV). Increasing your down payment proves to the lender that you are committed to your project.
Improve Your Credit Score
Although most hard money lenders do not qualify their borrowers based on credit, it does help to have your credit up to par. This proves to the lender that you have financial literacy. The hard money lender will also be more confident that you will not default on the loan.
Start Your Project Today
As you now know, hard money loans are crucial for many real estate investors. They use these loans to buy properties and fix them up within a short amount of time so they can put them back out on the market.
Now that you are more familiar with how these loans work, it is time for you to start your rehab project today. Apply now to see what you qualify for!
If you have any questions or concerns, you can contact us for help throughout the application process. We also have resources available for you to review.