Are you considering a hard money loan but want to know more about the loan terms, monthly payments, and the approval criteria that must be met before you fill out an application?
Read on to learn more about hard money lenders, how hard money loans work, and what makes hard money lending the ideal choice for real estate investors.
What are hard money loans?
A hard money loan is also known as an asset-based loan where, in most cases, that asset is real estate. When a borrower needs to secure financing in order to purchase an investment property, be it residential or commercial real estate, the value of the property plays more of a prominent role in the approval process over the borrower’s credit score or credit history, income, and the other usual factors that are taken into account.
A hard money lender also uses the after repair value of the property, if repairs are required, to make lending decisions. It’s worthwhile to note that hard money lenders do not lend against primary residences, although such properties can occasionally be used as additional collateral to increase the total loan amount.
Hard Money Loans vs Traditional Loans: What is the Difference?
Besides the factors that are considered during the approval process, there are a number of contrasts between a traditional loan you would get from a bank and a hard money loan or private money loan.
A private money loan is typically considered a short term loan that usually runs about 12 months, though some private money loans can be extended over longer periods of time, such as to 36 months. By contrast, a traditional mortgage loan typically spans between five and 30 years.
One of the main reasons why real estate investors in particular favor hard money loans over conventional loans is due to the former having a much faster approval process. Since the loan amount offered by a reputable hard money lender is based on the value of the property being purchased (or used as collateral with a cash-out refi), it’s a quick decision without needing tons of additional documentation, which is often the case with traditional loans. Therefore, the hard money process is quick and simple, and accordingly, investors can expect to have access to the financing they need much quicker than with traditional lenders.
What are the loan terms when using a hard money lender?
One of the many advantages of working with a hard money or private money lender is that your terms are often much more simple. Hard money loans are typically one year in duration and payments are interest-only. Therefore, there is no amortization, and the monthly payments are significantly lower than a traditional bank loan in which a portion of principal owed is repaid monthly.
The purpose of a hard money loan is to provide a bridge loan until a long-term alternative for financing can be identified and put in place. In some instances, private money lenders will approve borrowers who can’t get a conventional loan through a bank or credit union. The reason may be due to the condition of the property (for example, no certificate of occupancy), a low credit score, or fast timing. In any case, while a hard money loan will typically have a higher interest rate, the process will be significantly more straightforward and much faster when compared to a bank.
Hard money lenders have more freedom to work with borrowers who need to customize their loan terms so the financing and rehab reimbursement schedules are more amenable to the borrower’s outlook, time-frame, expectations for project completion, and the loan terms can also accommodate any partnerships or other interests in the property.
How does a hard money loan work?
Hard money lenders will issue a loan to the borrower based upon the value of the property that is either being purchased or used as existing collateral. Hard money lenders do not look at income or measurements such as debt to income ratios. Many real estate investors do not have consistent income, and the nature of the business sometimes results in a hit to their credit scores. Therefore, loans based on the value of the property are much more investor friendly.
To get a hard money loan, an appraisal is typically required. Title must be ordered and reviewed, and the borrower should have legal representation – you’re obtaining a mortgage after all. What is skipped are lengthy document requests, a months long back and forth with an underwriting team, and the need for a good credit score.
Borrow Money Faster
Hard money lending offers borrowers a faster way to get the money they need when competition for a property gets fierce and multiple buyers are interested. In a situation like this, when time is of the essence and a cash offer is required, traditional financing contingency can put the borrower at a disadvantage.
The traditional bank financing process can take anywhere from 60 days to 120 days for the loan to be reviewed, approved, and funded in full based on the type of property loan the borrower has requested. Those time frames can put you at a significant disadvantage when a hot property is on the market in a popular area.
Hard money lenders can fund any type of property within a 3 week timeframe. In fact, most loans are funded much faster – typically, within 12 or 13 days. In fact, if the property already has an appraisal, and title has been ordered, a funding timeframe of 3-5 days is not unheard of.
Borrower’s Creditworthiness vs. Property Value
The borrower’s credit history, debt-to-income ratio, employment history, loan amount requested, can have a negative impact on the stringent approval process of traditional lenders who may deny a real estate loan to applicants with, for example, high annual incomes who are also carrying a high amount of debt.
While it is essential that any lender take the necessary precautions to ensure that a borrower has the financial ability to reimburse that lender for the loan, when a potential borrower can demonstrate his or her income stability and capacity for paying back the money owed, yet still be denied because of their credit history, there are few alternatives left for access to funding.
Working with hard money lenders can reduce those barriers and give deserving applicants the ability to secure the loans they need to purchase or invest in real estate. A hard money lender will accept the property as collateral and eliminate the other obstacles to a loan approval.
Understanding the Loan to Value Ratio
Most hard money lenders will lend 60% to 80% of the current collateral value, depending on the property type, value-add opportunities, and overall scenario.
Condition of the Property
Banks tend to shy away from lending money to borrowers who are interested in purchasing a property that needs a significant amount of renovation. A conventional lender is bound by a rigid set of guidelines that must be considered before a loan can be approved and when it comes to lending on a property that requires major repairs, chances are the bank is going to deny the application.
But private lenders who issue hard money loans are more likely to work with house flippers who see a dilapidated property as a diamond in the rough or a borrower who wishes to invest in a commercial property that is only 50% leased.
For those borrowers who want to purchase a property that needs some repairs, a hard money lender may consider the After Repair Value (ARV) instead of the current loan-to-value ratio. This can put a hard money lender at a higher risk when underwriting the loan, so these types of private loans typically come with higher interest rates, more points, or other features that mitigate risk.
Since properties that need extensive rehab inherently carry execution risk, the borrower will need to demonstrate sufficient equity for a hard money lender to provide a loan. If a commercial property has very low occupancy, a hard money loan could be used to purchase the property, stabilize the property by leasing it up, and then refinance out with a conventional lender.
Primary Residence Purchases
Hard Money Loan Rates and Fees
The benefits of hard money loans may come with higher interest rates for some borrowers. Interest rates are typically determined by a range of factors, including some that a traditional lender may also use.
While hard money lenders tend to make their decision to approve a borrower based on the value of the asset being purchased, the rate a borrower will pay on a hard money loan is determined on the creditworthiness of the borrower, and this is when his or her credit history can have an effect on the loan. A lower credit score or complicated credit history can result in a higher interest rate.
Other factors that play a role in the decision include loan to value ratio, the amount of equity the borrower owns in the property, the condition of the property, and where the property is located.
Origination fees, processing fees, application fees, appraisal fees, and other upfront fees can also be charged with hard money loans. Not all hard money lenders include these fees in their lending agreements, so it’s important to do your homework when looking for the right hard money lender to serve your needs.
West Forest Capital: The Hard Money Loan Pros
West Forest Capital is the leader in hard money and private money lending, providing short term loan options that meet the specific requirements of borrowers.
We lend on all types of situations and scenarios: fix and flip, distressed properties, foreign nationals, fast closing requirements, auctions, divorces, partnership breakups, cash-out refis, and others – you name it, we’ll do it!
Call us today to discuss your funding needs to determine if a hard money loan is the right choice for your scenario. When conventional lenders are inadequate to get you the funding you need on your schedule, West Forest Capital can be a valuable ally to help fund your real estate investment property.
