What is hard money in real estate? Is it a safe bet?

Imagine you find a great real estate investment opportunity, but your credit score isn’t ideal. One of your options is a hard money loan. So, what is hard money in real estate, and is this type of loan risky? Well, hard money loans can help you buy a property, with short-term funds, even with bad credit or no credit history. However, these loans come with their own set of challenges. Here, we’ll explore what hard money loans are and their pros and cons in real estate investment. 

What is hard money in real estate?

Hard money loans, also known as bridge loans, are short-term loans. They are primarily for real estate investors, such as house flippers or property developers who renovate properties for resale. 

Keep in mind that these loan types are distinct from traditional bank loans. They are typically funded by private lenders or investor groups and use real property as collateral. 

This makes them an attractive option for borrowers who might need a better credit score but may possess valuable assets. The key appeal of hard money loans lies in their ability to provide quick cash, enabling investors to seize lucrative real estate opportunities swiftly. However, this speed and accessibility come at a cost, as hard money loans carry higher interest rates and shorter repayment periods compared to conventional financing. While they are a popular choice for managing multiple house flipping projects or dealing with foreclosure situations, borrowers must carefully weigh the risks and rewards due to the high costs and tight timelines associated with these loans.

Keep in mind that hard loan interest rates and fees usually depend on the loan amount and the significance of the deal to the lender.

How does a hard money loan work, in real estate?

Hard money loans are primarily secured by the value of the property itself rather than the borrower’s creditworthiness or financial profile. The amount of the loan is usually based on the property’s value, and the repayment term is short, often less than a year. 

The short repayment period allows hard money lenders to expect repayment in a relatively brief timeframe, minimizing their long-term risk. These loans often come with high interest rates and can be interest-only loans with a substantial balloon payment at the end of the term. This structure does increase the risk for borrowers, as they need to ensure they can repay the full amount quickly.

Simply put, these loans offer a fast and flexible financing solution for property investors, but the high costs and repayment pressures require careful consideration and planning.

Who benefits the most from hard money loans?

Hard money loans suit specific types of borrowers. These include property flippers who need quick financing to purchase and renovate properties for resale. 

Additionally, borrowers who do not qualify for traditional loans due to poor credit or other financial issues often turn to hard money loans as an alternative. 

Lastly, homeowners facing foreclosure, but who have substantial equity in their homes, may also benefit from hard money loans to secure the necessary funds to avoid losing their property.

How is a hard money loan different from a traditional mortgage loan?

Hard money loans differ from traditional mortgages. Firstly, the loan application and closing process for a hard money loan is generally much quicker than for a conventional mortgage. While a traditional mortgage might take weeks or even months to finalize, a hard money loan can often be secured in a matter of days. Additionally, the repayment terms for hard money loans are much shorter, typically ranging from six to 18 months, compared to the 15- or 30-year terms common with traditional mortgages.

Interest rates for hard money loans are also significantly higher than those for traditional mortgages.

Unlike conventional loans, where the borrower’s credit score plays a major role in the underwriting process, the value of the property itself is a primary consideration for hard money lenders. This makes hard money loans an option for those with less-than-perfect credit but substantial assets.

Moreover, hard money lenders typically require a larger down payment compared to traditional mortgages. While conventional loans can sometimes be obtained with as little as 3 percent down, hard money loans often demand at least 20 percent to 30 percent or more. This higher upfront cost reflects the increased risk that hard money lenders take on.

Also, hard money lenders operate differently from traditional lenders. Similar to payday lenders, they face minimal oversight or regulation. This lack of regulation allows them significant flexibility in their lending practices.

How are hard money loans different from soft money loans? 

Hard money loans and soft money loans serve different financing needs. Hard money loans are short-term, high-interest loans funded by private lenders. They are based on property value rather than borrower credit score. And, are ideal for real estate investors needing quick cash. 

In contrast, soft money loans resemble traditional mortgages, with longer approval times, lower interest rates, and longer repayment periods. They are heavily dependent on the borrower’s creditworthiness. For example, a real estate investor might use a hard money loan for a fast property flip or a rental property, while a homebuyer would secure a soft money loan for a long-term mortgage.

Are hard loan money loans risky?

Hard money loans entail risks mainly due to their higher interest rates, shorter repayment periods, and fewer regulations compared to standard mortgages. As a result, borrowers have minimal protection or recourse if they struggle to repay the loan. Additionally, using a hard money loan for house flipping carries the risk of being unable to sell the property. This could leave the borrower responsible for a substantial debt and potentially face property loss.

What are the pros and cons of hard money loans?

Advantages of hard money loans

• Hard money lenders offer negotiable loan terms. 
• They are not bound by conventional regulations.
• Hard money loans are processed quickly. They are ideal for fast property purchases or competitive auctions.
• Don’t require a strong credit history. The loan approval is based on collateral rather than credit score.

Disadvantages of hard money loans

• Hard money loans entail higher interest rates, upfront fees, and closing costs, resulting in significant expenses.
• Hard money lenders require substantial assets and offer lower loan-to-value (LTV) ratios, limiting borrowing capacity.
• Lenders must comply with laws ensuring borrowers’ repayment capability, potentially restricting eligibility.

What is the best way to get a hard money loan?

Securing a hard money loan involves several essential steps once a down payment is ready. Remember that certain hard money loans can be finalized within a few days. Some may take as little as a week to close.

• Find a reputable hard money lender by seeking referrals from real estate professionals, checking with title offices, or searching online.
• Apply for the hard money loan by meeting specific lender requirements such as credit score, debt-to-income ratio, and down payment.
• Gather necessary documentation including identification, income records, and bank statements.
• Compare offers from multiple lenders to ensure favorable terms regarding interest rates and fees.
• Initiate the loan application process with the selected lender.

Last thoughts

While hard money loans can serve as a valuable resource for those seeking financing through unconventional means, it’s essential to acknowledge their drawbacks. These include high interest rates and substantial risk if repayment becomes challenging. 

If hard money loans aren’t the right fit for you, there are several alternatives available. These may be private money loans, HomeStyle loans by Fannie Mae, cash-out refinancing, a home equity line of credit (HELOC), or a Federal Housing Administration (FHA) loan. Whichever type of loan you choose, make sure it’s a smart financial decision.

Written by Ramona Sinha. July 7, 2024

Ramona is the Senior Content Writer for Kukun. This experienced blogger uses simple and succinct words to decipher the complex phenomenon called life. She has written articles covering a broad range of topics, such as real estate, lending and mortgage, finance, business, taxation, home designs, home improvement projects, decor concepts, and more. An avid traveler, she’s a digital nomad at heart and an animal lover from the depth of her soul.