How Does Hard Money Lending Work?

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If you’re new to real estate investing, the chances are good that you will have come across the term “hard money loan” somewhere online. Hard money is an alternative approach to borrowing that doesn’t involve the typical mortgage lenders like banks. This type of real estate financing holds a lot of potential for investors that know how they work and how to leverage them correctly. In this guide, we’ll be taking a closer look at how hard money lending works and what a new investor needs to know.

Hard money loans, also known as asset-based loans, are loans that are granted by private investors with a special focus on real estate. When a bank is unlikely to approve a loan application, or the funding is needed quickly, then a hard money loan is a good solution. This type of funding is very different from getting a mortgage, and there are several things an investor should be aware of before applying for one. 

We’ll be looking at how hard money loans work, the types of properties these loans are best for and other terms a real estate investor can expect from this type of financing in this article:

Table of Contents

What Is Hard Money Lending?

Hard money loans are loans that are granted based on the value of the property the borrower is applying to get funding for. Secured by property, hard money loans don’t have to prescribe to many of the restrictions placed on traditional lenders, causing them to have different requirements and loan terms than banks would have.

When it comes to traditional mortgage loans, for example, the lender will need concrete proof from the borrower that they’ll be able to repay the loan. This means they’ll look into things like the borrower’s credit scores and current level of income before approving the loan application. If they consider the borrower’s financial history to be unfavorable or the property investment too risky, they’ll reject the application. 

So why is traditional lending not applicable to all types of real estate? Can’t you use a simple mortgage to buy an investment property? The answer is no. Some investment properties are in a rundown condition or in foreclosure and can be pretty risky to take on. Banks aren’t fond of risky investments and are unlikely to fund the investor that is interested in buying one. 

The other problem with traditional lending is it’s a time-consuming process. Even if you’re the ideal borrower, a loan application with a bank can take weeks to finalize. With hard money lenders, the opposite is true. Lenders like New Silver are able to grant initial loan approval online and close within 7 days. Since they are more focused on the collateral securing the loan, meaning the property, the borrower’s personal financial details become less important. 

The majority of hard money loans are short-term loans lasting a few months to just over a year. As mentioned above, these loans are funded by private investors, which means interest rates can be higher than traditional loans. 

Hard Money Loan Breakdown

Each loan situation will differ, but there are some key ingredients in hard money loans that you can get familiar with now. Hard money lenders are ultimately private lenders, and that means that their practices will differ from location to location and lender to lender.

The first thing to look at with a hard money loan is the terms. A typical hard money loan is short-term and needs to be repaid within about six months. This is good for the investor that is wanting to keep their costs at a minimum – the longer you are responsible for loan repayments, the higher the interest rates will end up being. Think about a house flip. The faster the investor is able to sell it, the better for their profits at the end of the day. Still, there are some lenders that will have longer-term options if that’s what you are looking for.

Next are the interest rates. Compared to a traditional loan like a mortgage, the interest rates on hard money loans will seem high. Hard money loan rates can easily range between 8-16% depending on where the lender is located and their internal requirements for borrowers. The reason these rates are so high is that hard money loans are commonly granted to borrowers working on risky properties. Remember that these lenders put less stake in your financial history, so there is a need for them to protect their investment too.

Another thing you need to be aware of when dealing with hard money lending is the points associated with the loan. Most hard money loans will have points that apply, also known as an origination fee that is supposed to cover the costs of granting the loan. Points are calculated on a percentage basis but usually range between 3-11% depending on the borrower’s unique application. These points are then paid by the borrower when the loan is granted.

Lastly, there is the down payment. The majority of hard money lenders will require the borrower to put some of their own money forward to secure the loan. The size of the down payment needed will vary depending on the lender, but generally, it’s expected that you are willing to pay at least 10% of the property’s assessed value. Down payments are ultimately calculated using the loan to value or LTV of the home.

Alternatively, you may end up dealing with a hard money lender that prefers to use the after-repair value or ARV instead. This is typically used in situations where the borrower does not have enough of their own funds to pay for renovations. When using ARV however, the interest rates can be higher to make up for the level of risk. 

But what if you as the borrower have no money to put down? Some hard money lenders are willing to finance up to 100% of the property’s purchase price. This may come with the caveat that fees and interest rates will be much higher unless you’re an expert investor that comes with a long line of successful projects.

Why Use Hard Money Loans?

Hard money works great in situations where traditional funding falls short. Traditional mortgages can’t cover every situation. House flipping is one of the main reasons why hard money loans are used, although they are also used for the purchase of small-balance commercial properties. 

There are many significant benefits to using a hard money loan for your next real estate investment.

The first is speed. Hard money loans can be closed much more quickly than loans from a traditional loan institution. Banks usually take their time assessing the loan applicant and property. For real estate investors looking to close on a deal quickly, this time-consuming process could actually cost them the project. With hard money loans, however, loan applications and closing is handled much faster. Once approved for a hard money loan, you’ll be able to build a relationship with the lender that ensures the process is even more streamlined next time.

The next benefit is the flexibility. Traditional loans like mortgages usually have pretty rigid requirements and underwriting processes. Hard money lenders, on the other hand, are able to assess each application individually and work with the borrower to reach agreeable terms for both parties. Things like repayment schedules can be adjusted, for example.

Finally, there is the benefit of hard money loan approval. For hard money lenders, the most important thing is the collateral the loan will center around. This means the borrower does not need a perfect financial history or credit score to get approved. Since hard money lenders are usually made up of a group of private investors, they’ll require less documentation than a bank would, making your application much simpler. 

When Does Hard Money Work Best?

Hard money loans work best in situations where short-term funding is needed. House flipping is an ideal use-case for a hard money loan. They want to own a property just long enough to improve the value and then sell it for a profit. This type of loan is not a good fit for buying primary residences that you want to live in long-term. 

The best uses for a hard money loan include:

  • Financing a fix and flip that sticks to a tight timeline
  • To cover the gap between buying an investment property and getting longer-term financing, also known as a bridge loan

There are several other use-cases, but the above are the most common. It’s important to note that hard money loans are not suitable for buying primary residences, and are much better suited to investment properties.

Finding The Right Hard Money Lender

To get started with your first hard money loan, you’ll need to take the time to find the right lender. Not all lenders are alike, and when it comes to hard money some lenders will offer much more favorable terms than others. 

To find the right hard money lender, start by connecting with other real estate investors in your area. Try and find some details for lenders you can follow up on later. 

When assessing the lenders you came across, you’ll want to look for reviews from previous borrowers on multiple platforms. What do they say about their experience with that specific lender? You’ll also want to take a careful look at the different terms the lenders offer and decide which one is closest to your goals for your investment property. Contact your shortlisted options and have a conversation about your project before you finish applying for a loan.

New Silver is a data-driven and technology-first hard money lender operating in multiple states across the country.  New Silver’s proprietary technology automates and streamlines loan originations while using data to reduce loan default risk. New Silver offers fast closing and terms up to 24 months for real estate entrepreneurs, and has a variety of loan products available, including ground-up construction, fix and flip loans, fix and rent loans, bridge loans, and cash-out refinance loans. Interested borrowers can visit https://newsilver.com to apply for a loan.