Are you wondering how to finance your next real estate investment? There are many financing options available to real estate investors, and choosing the right financing for your project can have a major impact on your bottom line.
Hard money loans are a common financing strategy for some investors working on short-term projects. But before you commit to a hard money loan, it’s important to understand how they work, when they’re best used, and what the potential downsides are.
All of that information will be covered in this quick guide to hard money loans.
What Are Hard Money Loans?
Hard money loans are a form of short-term funding, secured by collateral and issued by private lenders rather than banks. These loans are often used in real estate investing, particularly when an investor cannot qualify for favorable terms from a traditional lender.
The short-term nature of hard money loans has earned them the name “bridge loans” as they simply bridge the financial gap for a short time.
When Are Hard Money Loans Used?
Because hard money loans are short-term lending instruments, they are used when an investor expects to repay the loan quickly, typically within a year or two. This typically limits their use to flips and small developments.
Flips are when you purchase a property to renovate and resell. This can be done with a single-family home, multi-family property, or even commercial real estate. Investors can use hard money loans to purchase and/or renovate the property, then repay the loan in full when they sell it.
The construction of a small development can be funded in the same way. Investors borrow hard money funds to purchase and/or build a single-family home, small multi-family building, or small commercial space, then repay the loan when the newly-developed property sells.
How Do Hard Money Loans Work?
Unlike traditional loans, which rely on the borrower’s creditworthiness to determine who qualifies for a loan, hard money loans rely on the value of the property that secures the loan. Specifically, hard money lenders assess the after-repair value (ARV), which is the estimated worth of the property once the development or renovation is complete. Depending on the lender, real estate investors may be able to borrow 60-75% of the ARV as a hard money loan.
Since these loans don’t rely on the borrower’s financial qualifications and credit history, the approval process can be much faster, with loans often being funded in as little as 10 days (compared to the 30-day range of many conventional loans).
If the borrower fails to repay the loan as scheduled, the hard money lender can seize the property to offset (or fully recover) their losses.
Hard money loans are riskier for lenders, so hard money lenders typically charge much higher interest rates than traditional lenders. Borrowers could see hard money rates around 10 percentage points higher than conventional mortgage rates. This high cost has caused this type of financing to be known as a “loan of last resort.”
What Are the Benefits of Hard Money Loans?
Hard money loans offer several advantages, including:
- Convenience. In real estate investing, time is money. And hard money loans can typically be approved much faster than traditional financing, allowing investors to jump on opportunities quickly.
- Flexibility. Since hard money loans are provided by private lenders rather than financial institutions, you may have more wiggle room to negotiate the terms of the loan. The interest rate, closing costs, and repayment schedule may all be negotiable.
- Options for investors with lower credit scores. Real estate investors who cannot qualify for traditional financing may still be able to buy a short-term investment with hard money loans.
What Are the Downsides of Hard Money Loans?
There are a few potential disadvantages to be aware of when considering hard money loans:
- Cost. Borrowers pay a much higher interest rate with hard money loans than with traditional financing. Closing costs may be higher as well.
- Short repayment period. The real estate project must remain on schedule so the borrower can sell the completed property in time to repay the loan before the maturity date. Some lenders may be open to modifying the terms of the loan if the project runs late. If the lender will not modify the loan, the borrower may have to take on a new hard money loan to repay the original loan as scheduled.
- Risk of losing the property. Any time property is used as collateral to secure a loan, there is a risk of losing the property if the loan cannot be repaid. This risk can be mitigated through creative financing (like loan modifications, refinancing, or borrowing from a new lender to repay the original lender if necessary).
Skip the Financing Hassle with Gatsby Investment
Gatsby Investment makes real estate investing easy by handling every aspect of each deal for our investors.
We scout and acquire properties, secure financing, manage construction, and take care of the resale so our investors can enjoy purely passive returns.
And, since we pool money from multiple investors through the syndication model, you can buy into a deal with as little as $10-$25K!
Real estate investment financing is a complex system with many moving parts. Rather than trying to navigate this on your own, leverage the experience and knowledge of the experts here at Gatsby. Explore our available real estate syndication investment opportunities and choose your next real estate project today!