What is a Hard Money Loan?
Hard money loans are high-interest mortgages available from private investors. Desperate borrowers with poor credit scores, bankruptcies, no verifiable income, or too much debt often take out hard money loans when they are unable to qualify for traditional mortgages. Hard money becomes a last resort when borrowers cannot meet the lending standards set by banks or government sponsored enterprises such as Fannie Mae and Freddie Mac.
How Hard Money Loans Work
Private investors are willing to create hard money loans in return for charging a very high interest rate (often about 11.5% plus five points for residential home purchases). You meet a minimal set of requirements, make a monthly payment to the investor, and find a way to either sell your property or pay the balance when it becomes due. Hard money loans use the borrower’s property as collateral. They often offer interest-only payments and tend to have shorter terms (usually fifteen years or less). You can take out a hard money loan for either a home purchase or a second mortgage.
Hard Money Loan Requirements
Unlike most mortgages, the majority of hard money loans have only two requirements. Borrowers must have a significant amount of equity in the property and they must have an exit strategy to relieve themselves of the loan. Credit scores, employment, bankruptcies, and income are of no concern.
The borrower’s equity is the most important factor hard money lenders consider. If you are purchasing a home, you’ll need to bring a significant down payment to the closing table. If you are refinancing your existing mortgage, you’ll need to prove equity through a property appraisal. In today’s market, hard money lenders generally require borrowers to have no more than 65% loan-to-value for home purchases and 60% loan-to-value for refinances. Lenders know that without a significant stake in the property, borrowers are more likely to default on their loans. They want to make sure that the borrower has something to lose. No equity, no deal.
Hard money lenders also need to make sure their borrowers have an “exit strategy.” Since hard money loans tend to have such high interest rates, most borrowers see these mortgages as a temporary solution. Before giving you a loan, your lender will want to know how you intend to satisfy the debt. Acceptable hard money loan exit strategies may include: using the loan for only a few months before selling the property, using the loan to make property improvements before flipping the house and profiting, using the loan to pay off credit card debt and refinancing after improving your credit score, or using the loan to pay for a home while securing a job that will make refinancing possible. If you have a plan to pay off the debt in place, your hard money application is more likely to be approved.
Where to Get a Hard Money Loan
You can’t get a hard money loan by visiting the local branch of your bank. Instead, you’ll need to seek out mortgage brokers who have significant experience working in this field. Your run-of-the-mill mortgage broker will not have the connections necessary to make these unique deals go through – most are not trained in hard money lending and will not know where to start. Experienced hard money mortgage brokers work directly with private investors and hard money mortgage bankers to find a workable loan for their clients. Sometimes, you can work directly with a mortgage banker who will fund the hard money loan themselves. In this case, you get to skip the mortgage broker middleman. However, if the loan does not go through, you will have to start over again with a new lender, new appraisal, etc.
Hard Money Loan Pros and Cons
For desperate borrowers, hard money loans can truly be a lifesaver. Hard money lenders may be willing to give you a mortgage when no one else will. In a few years, you may be able to refinance your loan to a more affordable rate.
On the downside, your interest rate will be very high. Unlike your standard 30-year mortgage, hard money loans are meant to be a temporary situation. If you find yourself unable to sell or refinance your property when the time comes, you could be in trouble. Since hard money mortgages are backed by property collateral, defaulting on the loan will result in the loss of your home and, possibly, the equity you’ve built.
When considering a hard money loan, proceed with caution. There are certainly advantages, but high payments and short terms make hard money mortgages difficult to pay off.