What is a Hard Money Loan?
A hard money loan is a type of private loan, primarily used by real estate investors for the purpose of refinancing or purchasing a new property. Its purpose serves to bridge the gap in financing either when the borrower cannot qualify at a traditional lender due to bad credit and low income or needs access to capital in less than 30 days.
Because hard money loan approval decisions occur much faster than standard loans, the interest rate on them are traditionally higher. The approval process for a hard money loan is not determined by the credit score or income of the borrower.
In fact, getting approved for a hard money loan is primarily based on the equity of a real estate investor’s property.
The minimum equity level to qualify for a hard money loan is 30%. Individual lenders requirements may vary based on the risk of funding the loan.
A loan applicant can qualify for a hard money loan only if they own a property that can be used as collateral for the loan.
Hard money loans are not regulated by the government. The investors who provide the loans provide investors who have no obligation to shareholders, government institutions or other public bodies. Approval for a loan is solely based on the requirements of the specific investor whom the borrower is applying to.
Hard money loans are typically used on a short term basis. Because interest rates are about 20% higher than the traditional loan market, most real estate investors rely on hard money loans in time sensitive scenarios or when they do not qualify with a traditional lender.
An example of when a real estate investor would utilize a hard money loan:
A real estate investor finds a real estate investment that he believes has a lot of potential. Not wanting to lose the deal, because the deal requires the closing within 30 days, the investor applies for a hard money loan. He knows he cannot rely on traditional lenders to deliver funds in the 30 day required time frame.
Although the applicant may end up paying a higher interest rate for the property purchase, the purchase allows him to gain a solid business investment for his portfolio. Without the required capital for the transaction, the real estate investor would not be able to buy the property.
As previously mentioned, hard money loans are generally short term loans. To reduce his interest rate, the borrower refinances with a traditional lender after he purchased the property with the higher loan.
As can be seen above, the real estate investor takes advantage of the hard money loan program to be able to purchase the property. After the purchase was made, the borrower decides to refinance with a lower interest rate.
This type of creative thinking is what allows real estate investors to grow their businesses.