Hard money is an alternative funding method that can be used instead of traditional mortgage lenders. The financing comes from individuals or investors who lend their capital using the subject property as collateral. When you need a loan in a hurry, or when traditional lenders refuse to sign off on a loan, hard money is potentially the only option available to fix-and-flip real estate investors. Here’s an overview of how this unique type of loan structure work.
The Concept of Hard Money
The majority of loans require the borrower to offer some kind of viable proof of their ability to eventually repay the outstanding balance down the line. Typically, lenders want to review your credit score report and your current employment status and the amount of disposable income you’ll have on hand to repay the loan. If you can show a solid history of responsible borrowing and the ability to timely repay the loans as indicated by your debt to income ratio then you’ll have a good chance of being approved for a loan.
However, even if you are able to obtain a loan approval from a traditional lender, it is a painfully slow undertaking—even if you have a stellar credit history and ample income. If you have problematic events in your report, or an income stream that is difficult to verify to the lender’s satisfaction, the approval process can take even longer, or you may ultimately be denied financing.
Hard money lenders adopt a different approach. They issue funds based on collateral securing the loan and are accordingly less concerned about your ability to repay the loan balance. Collateral is something that helps secure a loan. When you borrow funds, you agree that the lender has the right to take something and sell it off to get their money back if you default on the repayment plan—thereby decreasing the inherent risk to the lender and improving your chances of obtaining funds. When it comes to hard money, the value of the collateral is more important than your personal financial situation.
Hard money loans are typically short-term loans, usually extending between one to five years in length. It wouldn’t be ideal to keep them significantly longer than that timeframe either due to the fact that hard money loan interest rates are on average much higher than those offered for traditional loans.
Reasons to Choose the Hard Money Route
If hard money is expensive due to the higher interest rate, what exactly is the appeal for fix-and-flippers? Here’s a quick look at some of the advantages of opting for hard money:
Because the lending entity is mainly focused on the collateral as opposed to your financial status, hard money loans can be applied for and approved more efficiently and in a shorter time window that conventional loans. After you’ve established a working relationship with a lender, the process can be expedited, giving you the ability to close deals that others can’t close—which is a huge plus when it comes to hot markets with multiple competing offers.
The terms for hard money loans can also incorporate a higher degree of flexibility than traditional loans. Lenders haven’t adopted a boilerplate underwriting process. Alternatively, they evaluate each deal on an individual basis. Depending on the specific circumstances of your fix-and-flip project, you may have the option of tailoring things like repayment schedules and timing.
The main factor for hard money lenders is the associated collateral. If you are acquiring an investment property, the lender will lend you as much as the property is valued at. If you need to borrow against another property in your portfolio, that property’s valuation is what the lender is concerned with. Even if you have a foreclosure or other negative events in your credit history, it is much less important from the lender’s perspective. The majority of hard money lenders keep loan-to-value ratios comparably low. They typically have a max LTV ratio between 50% to 70% so you’ll need assets to qualify for hard money. With ratios at that level, lenders are assured they can sell your property quickly and have a reasonable chance of being compensated if you default.
Hard money loans are ideal for those who need short term loans—such as fix-and-flip investors who will usually hold on to properties just long enough to increase the resale value. They’ll then sell the property and repay the loan typically within a year.