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A hard money loan is a type of short-term loan secured by real property. Their terms usually last between six and 24 months, and they have higher fees and interest rates. Hard money loans are mainly used to finance flipping homes, buying investment properties, and commercial real estate purchases. They are sometimes also used by borrowers with substantial equity and poor credit scores. Hard money loans often include both purchase financing to fund buying a property and construction financing to make improvements to the property. |
Hard money lenders are usually companies, private investors, or financing groups, not banks. Most of these lenders focus first and foremost on the value of the real estate put up as collateral for the loan.
Hard money lenders also care deeply about the real estate investor's experience and business plan for the property. For the lender, it pays off to receive the money back in a relatively short time and at a higher interest rate.
Some, maybe even most, look at the investor's credit score and depth of credit. Most hard money lenders tend to be more lenient on credit than traditional mortgage lenders. For example, they may have lower minimum credit score requirements.
The term construction loan generally refers to a loan for the ground-up construction of a new home or commercial building. It also includes purchase financing for the underlying real estate.
On the other hand, a renovation loan is a type of loan someone would need to remodel an existing building.
The main difference between a renovation loan and a hard money loan is that the renovation loan is only structured to finance renovation costs, not purchase a property.
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Short-term bridge loans are a subset of hard money loans. The key difference is that a bridge loan does not include the renovation or construction component. An example of this would be when real estate investors find a great deal on a piece of real estate and need a short-term loan to hold it briefly before selling it to another investor to fix and flip.
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Conventional mortgage financing, including loans from most local banks, has a stringent approval process that focuses heavily on a borrower's credit score, debt-to-income ratio, pay stubs, and cash reserves.
Even though hard money loans have more burdensome loan terms, such as higher interest rates and sometimes prepayment penalties, they are much easier to qualify for than conventional mortgage loans and typically don't require tax returns or income documentation.
If you want to purchase a rental property but have poor credit or credit issues you may need to consider hard money loans or their alternatives instead of conventional loans.
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Hard money loans are usually broken into two parts: the purchase of the real estate and the rehab.
The real estate purchase is relatively straightforward. The lender will typically size their loan amount to both the after-repair value, or Loan-to-Value (LTV), and the total cost of the project or Loan-to-Cost (LTC).
Once your loan is approved, you close on the purchase, usually with you funding the down payment and the lender funding the remainder of the purchase price and closing costs. There may be additional upfront fees, though some lenders charge no origination or processing fees.
The rehab process is where hard money loans get interesting. Let's say you now own the property and want to begin to improve it. You need funds to buy materials and pay contractors. Most hard money loans require you to front this initial investment in materials and labor.
After you've completed a phase of the work consistent with your renovation project, you request something called a construction draw from the lender. This means you can submit a request for reimbursement only after you've made renovations. So, in order to successfully use hard money financing, house flippers need to have enough upfront cash reserves for initial rehab costs, including labor and materials.
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Qualify based on property value: Unlike a traditional loan, hard money loans rely more on property value rather than personal credit history.
Fast closings: Often, hard money loans close in as little as a few days.
Quick approvals: Since personal income is not a determining factor, hard money loans offer much faster approvals.
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Short term financing: Real estate investors have less time to pay back their loans.
High rates and fees: Interest rates tend to be higher on hard money loans. They also often have higher fees.
Low LTVs: You're going to need a higher down payment.
Hard money loans are short-term loans, with two years typically being the longest term. Since the loan is due in full within two years, it is key to have an exit strategy to avoid paying a large lump sum. Below are some ways to repay your hard money loan.
This is the most common exit strategy for a hard money loan. A borrower will work with a hard money lender to finance a flip, flip the property, pay back their loan, and pocket the extra cash. However, flipping properties isn't nearly as simple as it may seem. To ensure a worthwhile ROI, investors have to rely on careful planning and work with a licensed contractor, as well as an experienced real estate agent.
In this strategy, rather than selling investment properties at the end of a flip, investors will keep them for long-term rentals.
Some investors are able to use the improvements put into the house to obtain a higher loan amount and actually pull cash out of the property. Others will simply obtain more favorable loan options, including loan rates and terms.
A few things to keep in mind for this strategy include:
Down Payment and Closing Costs – There are expenses in obtaining a new loan, and you will usually need to pay at least 20% upfront.
Prepayment Penalties – Some lenders have a prepayment penalty if you pay back the loan early. If your goal is to sell the property in the near future, pay close attention to the loan terms.
Visio Lending's primary focus is providing long-term financing to enable landlords to grow their rental portfolios. On the other hand, hard money lenders typically fund short-term projects such as construction, fix and flip, or rehabs.
Here's a closer look at some other distinctions between Visio Lending and hard money loans:
Credit Score – Visio Lending requires a minimum of 680, while not all hard money lenders require a credit report.
Appraisals – Visio Lending requires a third-party appraisal, but now all hard money lenders do. Some use a Broker Price Opinion (BPO) or other methods to determine lending value.
Property Condition – Visio Lending requires properties to be in C4 condition or greater, meaning we only fund rent-ready properties with no deferred maintenance. Hard money lenders finance construction and rehab projects, so they do not require move-in-ready property conditions.
Visio Lending is the nation's premier lender for buy and hold investors offering, long-term loans for SFR rental properties, including vacation rentals.
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