Why Some Borrowers Prefer Hard Money Loans
The label “hard money lender” is a lender, sometimes private individuals, who make loans to people or businesses that banks and credit unions will not offer a loan. On the other side, a “soft money loan” are loans that are offered by traditional lending institutions; banks and credit unions. You will need to meet the traditional lender’s minimum credit and income guidelines to be approved for financing.
Many hard money loans tend to have short repayment periods of 12-60 months. The majority of people get a hard money loan to speed up the financing of real estate versus all the time it takes by a traditional bank.
One type of short term loan that’s commonly used by investors and home flippers to renovate a home to resell are bridge loans. Private lenders or investor groups are the main funders of this source as opposed to banks.
Borrowers applying for a hard money loan obtain their financing not based on their credit history but mainly on the property’s equity. To offset the lender’s risk, borrower’s need to either make a larger down payment on a purchase or need to have 25% or more equity in a refinance. This means you avoid the underwriter’s scrutiny of your credit report.
Although the borrower is decreasing the private lenders’ risk with the necessary equity, the loan’s interest rate and fees are much higher than what a conventional lender offers. Borrowers with assets but poor credit are likely to find more affordable loans with a hard money lender. However, a different property or a financial account could also be used as collateral, if the lender agrees.
Why choose a hard money loan?
Hard money loan are usually sought after because the borrower doesn’t meet the requirements of conventional financing or they need to obtain the funds in a couple weeks or days to close a deal.
Types of borrowers who tend to get hard money loans include:
- Home rehab & flippers.
- Homeowners who have significant home equity and may face foreclosure.
- Borrowers who aren’t eligible for conventional financing.
Fix and Flip Homes
Home flippers are people who purchase a home to gut or renovate it and then resell for a profit. Sometimes they have investor partners who assist with the project.
With a hard money loan, in a multiple-buyer scenario, the hard money borrower may have the advantage over a buyer who makes an offer with 30-days or more to close the transaction.
The higher interest rate and holding time is already factored into the home flippers profit margin. If you’re making $50-$100K on a fix n’ flip, paying a few hundred dollars more per month is pennies.
Homeowners behind on their mortgage with huge equity
There are homeowners who have plenty of equity in their home but for one reason or another are having trouble paying the mortgage and were served with a foreclosure notice. This is where the negative view of hard money lenders comes in.
The lender offers the homeowner a high interest rate knowing full well if they have problems paying the mortgage currently at a much lower rate how will they pay this loan if income is still a problem months later? After refinancing and pulling out some cash on either a new first mortgage or second mortgage, the hope for the homeowner is the get their income together within the next six months.
The normal maximum loan to value in a refinance scenario is 60-65% of the home value. This gives the hard money lender some comfort knowing that if the loan(s) goes into default again, the house can be sold, with paying off the first mortgage and get repaid their loan on the sale.
Advantages of hard money loans
- Accessible to people who have equity but are not eligible for traditional loans.
- The money is can be obtained quickly, sometimes within two-three days.
- An offer from a real estate investor with a hard money loan as financing is seen as strong.
- More negotiating power on price by offering a fast close.
- The borrower’s credit and income are not always necessary.
- Able to get approved for a loan with recent mortgage lates, short sale, foreclosure, or bankruptcy.
Hard money lenders don’t have to follow the time consuming rules that conventional mortgage lenders are subject to. For home flippers, hard money lenders want to know the estimated market value of the property after the planned repairs and renovations are finished. This estimate is called the “after repair value” or ARV of the property.
Negatives of hard money loans
• The interest rates are higher by 3-10 percent than conventional loans.
- The loan fees are expensive by as much as five percent of the loan amount.
- The required down payment is commonly 30 percent or more of the home’s value.
- There’s normally a prepayment penalty fee for borrowers who repay the loan before it is due.
Changing lending laws for hard money lenders
Federal and state laws prohibit a lender from lend to borrowers who cannot repay the loan. Therefore, by law, hard money lenders must confirm that a borrower will have the necessary funds to make the new monthly payment and any balloon payment at the end of the loan term.
