Hard money loans are short-term loans you can use to buy investment properties even if you don’t have great credit. But their high interest rates and short repayment periods make them risky.
Hard money loans can offer real estate investors a quick and relatively easy option for financing. While they might be an option for borrowers who don't have good credit, their relatively high interest rates and shorter repayment periods can make them risky.
A hard money loan is a type of secured loan that's used to buy hard assets usually real estate. Instead of relying on the creditworthiness of a borrower, hard money lenders instead weigh the merits of the investment that a borrower is looking to fund and use that investment as collateral.
You won't find these loans from traditional lenders such as banks. Instead, they come from individual investors, investing groups and financing companies.
Individuals and companies may take out hard money loans to purchase property as part of an investment. They might be amateur or professional home flippers who want to quickly buy, repair, upgrade and then sell a home. Or they might be looking to buy and repair a rental property, build a new property or purchase a commercial property for their business.
Hard money loans differ from traditional mortgages in several ways, including how they're typically used: Hard money loans are more often used to buy investment properties, rather than paying for a place to live. As with other types of loans, the requirements and terms can vary depending on the lender and deal. However, hard money loans generally share a few key similarities regardless of who is issuing them:
Fast funding: While closing on a mortgage can take 30 to 60 days, you can usually get a hard money loan in a few days or weeks.
Short-term loans: Hard money loans often have short repayment periods, which range from six months to several years. In comparison, mortgages commonly have 15- or 30-year repayment terms.
High interest rates: Interest rates on hard money loans can range from around 8% to 15%, which is much higher than what most people pay on a mortgage.
Interest-only payments: With a hard money loan, you might be able to initially make interest-only payments or defer hard money loan payments. With a mortgage, you'll generally start repaying the principal and interest immediately.
Less focus on credit: Hard money lenders might check your credit, request proof of income and ask about your experience with real estate investing. However, they're generally most concerned with the property's value. In contrast, your credit score and debt-to-income (DTI) ratio can be major factors in qualifying for a mortgage.
Require a large down payment: You may need to make a 20% to 35% down payment based on the property's current value or its after repair value (ARV). There are conventional mortgages that don't require a down payment, or only require 3.5% to 5% down.
Costs and fees: Mortgages and hard loans both have closing costs of around 2% to 5%, although these costs may cover different types of expenses. Both types of loans can also have penalties if you pay them off early, but hard loans may have lower fees or shorter penalty periods.
A hard money loan could seem like a quick and simple way to jump into real estate investing. However, their high interest rates and short repayment terms can make them risky for borrowers.
For example, you might make interest-only payments initially and then have to repay the entire loan at the end of a 12-month term. But if you buy a home to flip and there are delays during the repairs or you can't find a buyer, you may not be able to repay the loan on time.
Some hard money lenders allow you to pay a fee to extend the repayment term of your loan, but the fee and extra interest could outweigh your returns. And if you can't repay the loan, the lender could foreclose on the property.
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