Sometimes a traditional mortgage or other bank loan does not work for a particular business. Real estate investors often need alternate forms of financing to fund their renovation projects. Many turn to hard money loans, which are non-bank loans used by real estate investors who buy fix and flip properties. These loans offer fast money and require fewer borrower qualifications than other financing types to these investors, allowing them to complete their projects in a timely manner and profitable manner. Hard money loans do offer fix and flip buyers a number of advantages, but they also offer them some challenges.
Hard Money Basics
People turn to hard money loans because they are fast and require fewer buyer qualifications. When buying flip properties, buyers have to move quickly to beat out the competition. Traditional loans can take weeks or months to close. Banks also hesitate to lend money for properties that are not already in excellent condition since they only consider the current worth of the property. Flippers need lenders who consider the ARV (After Repair Value) since their aim is to buy properties that are in disrepair, fix them and then sell them for a significant profit. A loan for a majority of the purchase price is simply not enough.
Hard money lenders take a different approach toward borrowers as well. Credit scores are not as important for them as they are for a bank. A hard money lender bases their acceptance on the collateral for the loan, the property itself, and not the borrower’s personal finances. If the borrow cannot repay the loan, the lender simply takes the property.
Getting a traditional loan can be a long and grinding process. Hard money loans can be processed in two weeks or less and are for a shorter term than traditional mortgages, usually one to five years. That loan period usually gives the buyer enough time to finish renovations and sell the property, hopefully at a big profit.
Advantages of Hard Money Loans
Hard money loans offer borrowers a number of positive aspects. Real estate investors consider the speed of the process a major advantage of these loans since time is literally money for them. The faster the flip is finished, the more money they should make. Also, people with credit issues can receive financing that wouldn’t be possible through regular loans. The emphasis is on the property’s worth and the buyer’s expertise in the field.
Staying current with a hard money loan is easier than with traditional financing. During the duration of the loan, borrowers only make interest payments and do not repay principal until the property is sold or they secure other financing.
Disadvantages of Hard Money Loans
Hard money loans are costly, usually charging interest rates that range from 7% to 12%. Currently, traditional home mortgage rates are between 4.25% and 4.5%, significantly lower. Also, hard money lenders often charge steep lender fees, up to 10%. The borrower can afford these terms if their renovated property sells for a high enough price. If the property does not sell quickly, the costs can become unsustainable as a long-term expense.
Borrowers may have less power with these loans. Hard money lenders keep firm control of the money and dispense it in a series of payments at predetermined times. Sometimes this schedule leaves the borrower short on funds to continue the home rehab between payments.
Other Hard Money Borrowers
Fix and flippers are the most common hard money borrowers, but buy-and-hold investors may also use them. These buyers want to buy and renovate a property as a long-term investment and not just to fix and flip. Banks often will not lend them the necessary money because the property is not in good enough shape to justify the loan. In that instance, they may seek a hard money “rehab” loan. Once the borrower has renovated the project, they can then refinance their purchase into a permanent loan, rent out the property, and pay back the hard money loan. In this instance, the hard money loan serves as a bridge to traditional financing.
Hard money loans serve an important purpose in real estate transactions. They are a simple way to secure financing for flip and fixers when traditional loans aren’t available or simply do not make sense for the project. These loans are flexible, fast, and relatively easy to get since they rely on the property’s ARV instead of its current value. For real estate investors, they are a go-to method to finance their projects, which are often quite profitable. In 2017, house flippers made an average profit of $68,143 per unit, which is why the practice is still popular.
These loans do have limitations, including a high cost, particularly when compared to regular bank financing. The interest rate and initial fees will take a chunk out of future profits on the project. If something goes wrong with the rehab, the borrower can lose a significant amount of money. House flippers should explore all their options before taking out a hard money loan. In some instances, less expensive financing methods are available to the property buyer.