What is Hard Money Loan?
A hard money loan is a type of financing provided by non-banking institutions or individuals to the real estate investors. It doesn’t require much credit scrutiny as it is backed by collateral security. The investor prefers to choose a hard money lender since the loan is provided quickly say within a week as compared to traditional bankers taking approximately 1 to 2 months to disburse the amount.
This type of loan is also called a short-term bridge loan since it bridges the finance gap between purchase and resale of the property.
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How Does Hard Money Loan Work?
The job of a real estate investor is to identify a property. Purchase the property, make repairs or renovations on the property, increase its market value & resale the property.
- The investor usually faces financing issues at the time of purchase of property, and they require quick finance to make the property saleable immediately.
- Traditional bankers would never finance hard money loans since the ratio of loan to value may be high (over 75%). Thus, real estate investors choose private players who would finance the project.
- The real estate property is given as collateral security to the lender. The lender is not concerned with the income or credit history of the investor since the loan is for the short term.
Example
The investor has come across property & acquired the following information for a hard money loan:
Solution:
Explanation:
- The amount of finance provided by normal bankers is only 70% as compared to the hard money lenders. Further, the amount of down payment required by the investor is lower.
- The investor can manage repairs and incidental expenses within the savings available to them.
- Within the total span of 5 months, the investor can easily plan for repairs and renovation of the property.
- The return earned by the investor is handsome within the period given.
Who Do Real Estate Investors Prefer Hard Money Lenders?
- Investors trying to compete with many competitive bids should prefer choosing the hard money loan option, which will help them to get the deal quickly.
- Investors who have a bad credit history can use the hard money loan option to ensure quick disbursal without issues & inquiries. Such investors have high chances of rejection from traditional bankers.
- Also, new investors in the market will not have a healthy income history. Further, the investor can lower down his part of the investment in the real estate, which exposes him to lower risk.
Requirements
- The main requirement of the lender is that the property should be under collateral security of the lender.
- The credit history or credit rating of the borrower is not of concern to the lender.
- The lender is, however, concerned with the amount of investment to be made by the investor.
- The investor should produce the lender with the borrow and repayment plan for the said loan, convincing substantially about the repayment plan and date of sale of a security. Details such as the period of finance required are also to be mentioned.
Amounts for Hard Money Loan
- LTV ratio (i.e. Loan to Value ratio) specifies the amount of loan that can be sanctioned by the lender. LTV is calculated by dividing the loan amount by the value of property to be given as collateral security.
- Higher LTV means a higher amount financed by the lender & vice versa. Normally the traditional bankers offer 75% of the value as a loan.
- Private players offer an LTV of more than 75%. Now, what about the balance amount of finance? The investor from his pocket obviously finances it.
Advantages
- Quick disbursal of loan.
- Easy financing arrangement.
- Lower hustle for documentation & legal paperwork.
- Real-time quick & easy approval.
- No investigation required about the credit history or source of income of the investor or income history of the investor.
- Flexible options are given by the lender who makes the job easy.
- Easy close off by the investor.
Disadvantages
- The interest expense is much higher than traditional providers of finance.
- LTV ratio is higher for an experienced flipper only and not for a new player.
- Other incidental costs are also higher than in the case of traditional loans.
- Financing is rejected for the property that has a lower value against the valuation done by the investor.
- The lender prefers short term span of the loan period.
Recommended Articles
This has been a guide to what is hard money loan and its definition. Here we discuss how does it work along with an example, requirements, and amount. You may learn more about financing from the following articles –
