Real estate investment is a popular wealth-building strategy with a good return on investment (ROI) compared to other investment opportunities. However, real estate development projects require a substantial amount, which might be tough to raise through traditional loans.
Some reports have indicated banks are quietly dumping real estate loans, making it harder to refinance loans. This has made hard money loans viable options for many real estate investors.
Commercial Hard Money Loans are short-term loans commonly used in real estate investing due to their fast approval and flexible terms compared to traditional bank loans.
Financing real estate with hard money loans
Hard money loans are specifically designed for real estate investors, notably those interested in fix and flip. You can also use them for buy, rehab, rent, and refinance (BRRR).
Like any other kind of loan that can be used to finance real estate projects, it is vital you understand how it works and consider the pros and cons to decide if it is suitable for your investment strategy.
What is a hard money loan?
A hard money loan, also called a bridge loan, is a loan provided by private money lenders, investor groups, and financing companies. It is typically short-term, ranging from 6 months and up to 5 years, unlike conventional loans, which can extend up to 30 years.
Hard money loans are often secured by property collateral and based on the project’s potential value or the borrower’s equity.
Hard money lenders are known for their ability to provide funds quickly, often within a few days or weeks. This makes them a fantastic option for time-sensitive real estate projects.
These lenders are also more flexible than traditional banks when it comes to credit requirements and loan-to-value ratios. This is one of the reasons real estate investors prefer working with commercial real estate hard money lenders instead of conventional mortgages.
The quick provision of required funds helps borrowers land a good deal before it is snapped off the market by another buyer. The loan is usually repaid after remodeling the property and selling it.
How does a hard money loan work?
Banks and other traditional financial institutions do not offer hard money loans. Since the loan is secured by property, the lender, usually a private lender, has the right to foreclose on the property if the borrower defaults on the loan.
You will have to go through six processes to get a hard money loan:
- Application: Like traditional loans, you will need to apply with a hard money lender of your choice. In the application, the borrower is expected to provide information about the property, the proposed project, and their financial situation.
- Property appraisal: After reviewing the application, the lender will send a property appraiser to assess the value of the property to ensure it is worth collateral for the loan amount applied.
- Loan approval: The application details and the report of the property appraiser will be reviewed by the lender. The review this time will also include the borrower’s financial situation to decide whether to approve the loan.
- Loan terms: If the lender decides to proceed, they will outline the terms of the loan, including the interest rate, repayment schedule, and any additional fees.
- Disbursement of funds: It is recommended that you thoroughly read and understand the terms of the loan before signing. Once the terms are agreed upon, the lender will disburse the loan funds.
- Repayment: The borrower is responsible for making regular payments on the loan, including both principal and interest as agreed in the loan terms.
Hard money loans vs. traditional loans vs. soft money loans
Even though hard money loans, traditional loans, and soft loans are all financing options used in real estate investing, they have significant differences in terms of their structure, terms, and suitable use cases.
- Application time: Unlike traditional loans and soft money loans, hard money loans require less paperwork and, hence, are quickly processed and approved.
- Loan terms: Hard money loans typically have a shorter repayment period, often a few months and sometimes a few years. Traditional and soft loan terms can extend as much as 30 years.
- Interest rates: Due to the shorter terms and risk to lenders, hard money loan interest rates are usually higher compared to conventional mortgages and soft money loans.
- Collateral: Hard money loans are largely secured by the property value plus its After Repair Value (ARV). It is more flexible in terms of credit requirements and loan-to-value ratios, unlike traditional loans and soft money loans.
- Loan limits: Hard money lenders usually have higher loan limits, hence suitable for commercial real estate or the purchase of a unique property.
When to consider a hard money loan
Hard money loans are best for three types of borrowers:
Property flippers
Property flippers are people who buy properties to renovate and resell for profit. They prefer hard money financing due to its faster processing and approval.
Some borrowers may also opt for hard money financing if they need more money than bank loan limits.
Real estate investors who do not qualify for traditional loans
Borrowers can be ineligible for traditional loans due to several reasons, such as a low credit score, which might be affected by a recent divorce, a high loan-to-value ratio (RTV), a recent change in employment status, and problems with the property.
Hard-money lenders are more flexible with their terms.
Homeowners facing foreclosure with substantial equity in their home
Although rare, homeowners facing foreclosure and in need of urgent financing can get approved for a hard money loan, provided they accept the lender’s term to sell the house in case the loan goes into default.
In summary, as a real estate investor, below are some of the scenarios when to consider a hard money loan:
- Time-sensitive projects: When you need quick financing to purchase a property or complete a renovation.
- Credit challenges: Hard money loans have flexible terms, which makes them a viable option when you need quick cash but have credit issues that make it difficult to obtain traditional financing.
- Difficult-to-finance properties: Banks and other conventional lenders may reject loan applications to purchase properties that need fixing or are in distressed areas. Hard money lenders, on the other hand, are more likely to approve such loans.
How to get a hard money loan
Getting a hard money loan is different from traditional loans. While banks and other conventional lenders are easy to find, getting a reputable hard money lender can be challenging.
Find a reputable lender
Ask your contacts who work in real estate to refer you to a hard money lender. Title offices are another place to check.
The easiest way to find a hard money lender is to search online. However, do your due diligence, such as by reading online reviews to assess their reputation.
Check lenders’ requirements.
Check the eligibility criteria listed by the lenders you can find. Requirements vary by lender, but most of them will include:
- Minimum credit score (usually flexible)
- DTI ratio
- Down payment
- Income statements
Ask for the required documentation
Talk with the lender to request the required documentation to process the loan. Generally, this would include your identification, income information, and bank statements.
Compare lenders
Compare offers from multiple lenders to choose the one with the best terms for your investment.
Submit application
Submit your application for the loan for the lender to review. Some lenders may request you include in the application: the purchase contract and property info sheet.
