What is a Hard Money Loan?

What Is a Hard Money Loan?

A hard money loan is a type of loan often used to meet quick, short-term funding needs in the world of real estate. Unlike conventional mortgages, approval and the terms of the loan are primarily based on the value of a property, rather than the borrowers’ creditworthiness.

These loans can be lifesavers in situations where traditional financing options are either too slow or unavailable. For instance, a real estate investor might use a hard money loan to quickly purchase a property, renovate and then sell it at a profit.

In this post, we’ll take an in-depth look at how hard money loans work, explore their advantages and disadvantages, and highlight their best use cases.

How do hard money loans work?

A hard money loan is usually used to finance real estate projects. But unlike conventional home loans, which are typically offered by banks and mortgage companies, hard money loans are usually provided by private lenders.

In addition, the loan is asset-based, meaning that the lender primarily focuses on the value of the property being financed (or its after-repair value) rather than the creditworthiness of the borrower, as is typical with traditional home loans. Typical loan terms for hard money loans range from 6 months to 2 years, which again is shorter than the terms on most traditional home loans.

Since lenders face higher risk by prioritizing property value over a borrower’s creditworthiness, they usually charge higher interest rates on these loans — typically between 8% and 15%. For context, the average rate for a traditional 30-year fixed home loan is currently around 6.91%.

The upside is that hard money loans have a more flexible qualification criterion as well as a faster approval process.

Pros and cons of hard money loans

Pros¹

• Quick approval: The approval process of hard money is quite fast because the lender doesn’t have to conduct a long assessment of a borrower’s creditworthiness. Funds can often be available within days, a huge advantage over the weeks or months it typically takes to secure a conventional home loan.
• Flexibility: Hard money lenders aren’t bound by the same strict regulations as traditional mortgage providers. As a result, the terms of these loans are more flexible. For example, they allow for creative payment structures like interest-only payments followed by one large balloon payment of the principal.
• Less reliance on credit scores: Since hard money loans are based on the property’s value rather than the borrower’s credit history, they’re accessible even to those with less-than-stellar scores who might otherwise struggle to qualify for traditional financing.

Cons

• High costs: Hard money loans usually come with higher interest rates to compensate for the lender’s increased risk. Additionally, origination and closing fees tend to be steeper than those for conventional loans, which makes the total cost of borrowing much higher.
• Short repayment terms: Loan terms typically last from 6 months to 2 years. This limited time frame can be risky — for example, if a property doesn't sell as quickly as expected.
• Risk of losing property: Since hard money loans are secured by the property itself, the lender can seize the asset if you default on your payments. 

Best use cases for hard money loans

Hard money loans are ideal for specific real estate scenarios where quick access to funds is essential. Here are a few key examples.

• Fix and flip projects: One of the most popular uses for hard money loans is for house flipping. The fast approval process allows you to quickly secure a property, make improvements, and then sell it at a profit before the loan term ends.
• Bridge loan to long-term financing: Certain properties might not qualify for a conventional home loan in their current condition. Hard money loans can serve as a practical bridge solution. You can use one to purchase a property, complete essential improvements or renovations, and then refinance with a conventional long-term mortgage once the property meets the necessary criteria.
• Time-sensitive purchases: If you need to close on a property quickly — whether due to a competitive market or other urgent reasons — hard money loans offer a convenient solution. You can have cash in hand in a matter of days, compared to the weeks or months required for traditional financing. After closing, you can then refinance to a more affordable long-term financing option.

How to qualify for a hard money loan

Qualifying for a hard money loan is typically more straightforward than for a traditional loan, thanks to the asset-based nature of these loans. Still, there are some key factors that lenders consider:

• Loan-to-Value (LTV) Ratio: This ratio measures the loan amount relative to the property's appraised value. Different lenders have varying LTV limits, but most usually cap it at 60% to 70% of the property’s value. In comparison, you can secure up to 90% LTV with a traditional home loan.
• Exit strategy: A well-defined exit strategy is crucial for approval. Lenders want to know how you plan to repay the loan, whether through selling the property, refinancing, or other means. Having a solid plan reassures the lender that they’ll receive their investment back on time, thus increasing the odds of approval.
• Experience: While not always a strict requirement, experience in real estate investing can be a positive factor. For instance, if you have a long track record of successful house flips, this can enhance your credibility and increase both your likelihood of approval and the amount you can borrow.

Alternatives to hard money loans

Hard money loans as we’ve seen offer a fast, flexible solution for short-term real-estate financing needs. But depending on your situation, other financing options may be a better fit.

Traditional mortgages

If you have a strong credit score, a stable financial history, and can wait through a longer approval process, a conventional mortgage provides a more economical way to finance a property. Interest rates are substantially lower than those on hard money loans.  You’ll also have a longer repayment term, typically 15 to 30 years, making monthly payments more manageable.

Home equity loans

If you’ve built up sufficient equity in a current home, you might be able to borrow against it.  This type of loan is known as a home equity loan and typically comes with a lower rate than hard money loans. It provides an upfront lump sum, which can be used for renovations, or for non-real estate expenses.

A closely related alternative is a home equity line of credit (HELOC) whereby instead of receiving a lump sum, you get access to a revolving line of credit that you can withdraw from as you need up to a set limit. This makes it a flexible choice for ongoing or variable project costs.

The primary downside of home equity loans is that they are secured by your home, so if you default on your payments, you risk losing your home.

Unsecured personal loans as an alternative to hard money loans

If you prefer not to use property as collateral, unsecured personal loans offer a flexible, lower-risk alternative to hard money loans. Unlike the latter, unsecured personal loans don’t require property as collateral, which means your personal assets aren’t at risk if you can’t repay the loan.

Additionally, they offer flexible use cases, such as debt consolidation, paying for medical bills and funding large expenses like weddings, rather than being tied strictly to real estate transactions. You also benefit from longer repayment terms.

However, a strong credit profile is often necessary to secure the best interest rates.

How to compare hard money lenders

There are multiple hard money lenders out there, but not all are created equal. Take time to shop around and compare different lenders to find the right option for your needs. Here are some key factors to consider when comparing lenders.

• Interest rates: As we’ve already seen, hard money loans generally come with higher interest rates than conventional loans. Therefore, it’s important to compare offers to find the most competitive rate. Even a slight difference in interest can significantly impact the total cost of the loan, especially for large loans.
• Fees: Beyond interest, many hard money lenders charge additional fees, such as origination fees, closing costs, and processing fees. Carefully review the fee structure to get a complete picture of the loan’s cost. This will help avoid any unexpected charges and give you a clearer sense of the loan’s affordability.

Lender Reputation: Research each lender’s reputation by reading online reviews and checking their standing with regulatory bodies or consumer ratings bodies like the Better Business Bureau (BBB). This can give you valuable insight into the quality of their services and their trustworthiness.

Final thoughts: What is a hard money loan?

Hard money loans can be a valuable borrowing tool for real estate investors who need quick access to capital for short-term needs. They offer fast approval processes, flexible terms, and don’t rely on your credit score. However, they have some drawbacks too including high interest rates and a shorter repayment window.  Not to mention, there’s the risk of losing the property you put as collateral if you default on the loan.

If you're considering a hard money loan, be sure to do your research, compare different lenders, and understand the risks involved.

If you prefer not to put your property at risk, or if you need finances for purposes other than real estate, unsecured personal loans may be a more suitable fit. These loans often come with lower interest rates and longer repayment periods for qualifying borrowers. They also offer more flexibility in terms of use.

Ready to explore your unsecured loan options? Visit RISE Credit today to learn more and get started.

Sources:

1. Rocket Mortgage. "What Is A Hard Money Loan? Learn How It Works." Rocket Mortgage, https://www.rocketmortgage.com/learn/hard-money-loans

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