A brief summary
When we use the term “hard money loan”, we are referring to loans that use a hard asset as collateral, like property. Hard money lenders provide these loans which are short-term, with flexible loan terms and are typically easier to get approval for than traditional loans.
Hard money lending is usually linked to real estate, and real estate investors are the typical candidates for hard money loans. Now we’ll take a closer look at why real estate investors use these loans and answer the question, how do hard money lenders make money?
Why do real estate investors use hard money loans?
Real estate investors use hard money loans for a number of reasons. Here are some of the biggest benefits for real estate investors using hard money loans:
- Fast approval and funding: Hard money loans can be approved in as little as 10 minutes, and funding can be provided in a matter of days in some cases. This is a great benefit for real estate investors because they’re often looking to capitalize on good real estate investment deals amidst stiff competition, and this allows them to beat the competition by getting funding quickly for deals.
- Flexible loan terms: These loans can give investors flexible loan terms because they’re offered by private lenders who aren’t bound to the same rules and restrictions of traditional lenders. These lenders can be more flexible to take each loan on a case-by-case basis and even allow for negotiations on loan terms.
- Property as collateral: With hard money loans, the property itself is used as collateral for the loan. Which works well for real estate investors who can find good deals and use the investment property as collateral to get a hard money loan quicker and easier than a traditional one.
- Lower barrier to entry: Getting approval for a hard money loan is much easier than a traditional loan, so real estate investors are attracted to this option as there is simply less red tape. Borrowers won’t need to worry about having a particularly good credit score or debt-to-income ratio, because hard money lenders are less focused on the borrower’s personal finance, and more interested in the real estate deal itself.
- More options: Real estate investors who use a hard money loan are essentially leveraging other people’s money, which means that there are extra options that they can do which a traditional loan wouldn’t offer. Such as getting funding for more than one deal at a time or getting a larger loan.
How do hard money loans work?
Hard money loans are short-term loans that run between 6 and 24 months, with higher interest rates. They often only require interest payments until a certain time, then a balloon payment is required for the principal amount to be repaid. The After Repair Value (ARV) is considered a good indication for hard money lenders on how profitable the project will be, so this is a vital component. Hard money lenders will usually lend between 60% and 80% of the ARV amount to borrowers.
How do hard money lenders make money?
Hard money loan interest rates are higher than traditional mortgage loans. While traditional fixed-rate mortgage loans offer an average interest rate of 3.5%, hard money loan interest rates fall anywhere between 6% and 15%. The interest rate for hard money loans usually depends on the ARV value of the property, the loan amount needed and the borrower’s credit rating. The higher interest rates are charged to mitigate the risk for hard money lenders and this is one way in which hard money lenders make money.
Costs, fees and points
Hard money lenders also make money from the loan costs and fees which they charge, which also come in the form of points. Points are fees that the borrower will pay to the lender to cover the cost of putting the loan together. These points are directly related to the amount of interest being charged on the loan. For example, a loan with 1 point means that the borrower will pay 1% of the loan amount, so for a $100,000 loan this would be $1,000.
There are closing costs and other fees where hard money lenders make their money. These include the underwriting fees paid by the borrower to the lender for the service of underwriting, which determines the probability of the borrower to default on their loan. There’s a loan processing fee which must paid, as well as a document preparation fees which are necessary for the completion of the loan. Property inspections, in-house notary services and other fees can be added into the mix to create a bigger pool for the lender to draw money from.
Why is the number of hard money lenders increasing?
There is a growing need for short-term real estate loans, due to the fact that traditional lenders are often less willing to provide capital for house flipping projects. House flipping is one of the most popular ways for real estate investors to make money, so it’s essential to have a funding option for these investors that can fit with their needs.
Enter hard money lenders, who can offer short-term loans with a lower barrier to entry and quick approval process. As the need for these type of loans increases, so does the amount of hard money lenders, as per the usual supply and demand concept.
Now that you know more about why real estate investors use hard money loans, and you’ve found out how hard money lenders make money, you can make a more informed decision on hard money loans for your next real estate investment. Lenders like New Silver offer real estate investors a multi-use platform where they can begin their journey by finding the right investment property, get funding and then purchase the property, all in one place.