If you’re new to real estate investing, you may think getting the money to purchase and fix up a property is as easy as filling out a loan application at your local bank or credit union. Like other new investors, you’ll quickly learn that it’s almost impossible to get funding for this type of purchase from traditional lenders. A hard money loan is the solution many buyers turn to when they need a source of financing for fix-and-flips and other real estate investment deals.
If you’re not familiar with this specialized real estate financing tool, comb through these key facts that can help you decide if a hard money loan is the right option for you. In this guide we’ll cover:
- The basics of hard money loans
- Borrowing situations that call for this type of loan
- Typical hard money loan application requirements
- How much you can borrow and how long it takes to get the funds
- The payback terms
- How much hard money loans cost
- The pros and cons of this kind of loan
Hard Money Loan Basics
A hard money loan is a form of real estate financing offered by an individual or group of private investors instead of a bank, credit union or other traditional lender. The loan is backed by property that’s owned or being purchased by the borrower. Because these are private loans, each lender decides on the the property types and values they’re willing to finance as well as the requirements borrowers have to meet, such as minimum credit scores and equity contributions.
Although the specifics differ from lender to lender, most have a relatively simple application process. Approval for a hard money loan is generally based on the value of the real estate being used as collateral and the amount of money the borrower is investing rather than their credit history and income. The approval time frame for this type of loan is usually much faster than a conventional loan from a bank or other financial institution.
Loans for investment properties aren’t subject to the same government rules and regulations as residential loans and mortgages. Because of the red tape and restrictions on residential loans, many hard money lenders only finance investment properties and not owner-occupied, single-family homes.Take a look at some of the details for these popular hard money loan lenders:
|Lending Home||Visio Lending||Patch of Land|
|AmountsAvailable||Up to $1 million90% LTV, 75% ARV||Up to $2 million80% LTV||Up to $5 million plus80% LTV, 65% ARV|
|Speed ofFunding||As little as 15 days||As little as 7 days|
|Documents Required||Three months ofbank statementsList of past fix and flipprojects||Two months ofbank statementsList of past fix and flipprojects||Two to three monthsof bank statementsList of past fix and flipprojectsProof of fundsInspection report, if availableProperty comparisonsPurchase contractExperience listConstruction estimates,time frame and contractor informationLender-ordered appraisal|
|Cost ofFunding||Interest rates: 7.5 to 12%Lender fees (points): 1.5 to 2.5%Closing costs: 2 to 5%||Interest rates: 4.8 to 12.5% forlong-term loans,9.99% plus for bridge loansLender fees (points): up to 5%,standard is 2%Closing costs: $1,645Appraisal fee: $300 to $500 plus||Interest rates: 9.99 to 13% plusLender fees (points): 3 to 5%Closing costs: 2 to 5%Appraisal fee: $300 to $500|
|PaybackTerms||12 months||Two to 30 years||One to two years|
|Pros||No prepayment penalty,competitive rates,flexible productsquick processing||Flexible,long term loansoffered||No prepayment penaltyon fix-and-flip loans,fast funding time frame|
|Cons||Doesn’t offer commercialproperty or long-term financing||Prepayment penaltyon long term loansDoesn’t finance propertieswith more than 4 unitsDoesn’t offer commercialor fix-and-flip loans||Requires more documentationthan competitors,Requires high down payment,charges higher fees|
|Best For||Best overall for investorswho want competitive ratesand fast funding for residentialfix-and-flips||Landlords who want torefinance or grow theirrental portfolio||Fix-and-flip investors whowant an alternative to Lending Home,but with a commercial component|
Situations That Call for Hard Money Loans
Hard money loans can be used for a number of financing purposes. Because they’re typically approved and funded quickly, these loans are often used as short-term or bridge financing for investment properties that are going to be rehabbed and then sold again. They can be used for most types of investment real estate, including single and multi-family residential, industrial, commercial and undeveloped land. Since hard money lenders typically don’t scrutinize a borrower’s credit history, this kind of loan can be an ideal financing option for buyers with a low score or other credit problems who need short-term funding for investment real estate or, in some cases, a property they plan to occupy.
Most hard money lenders don’t offer loans for all types of properties or situations. When you’re searching for a lender, you’re likely to find that:
- Many only deal with short-term loans for projects in specific real estate niches, such as fix-and-flips, new construction, commercial property or raw land.
- A smaller number focus on long-term loans for rental property owners who want to expand their portfolios or refinance existing units.
- A fraction may offer loans for homeowners who want to refinance but can’t qualify for a traditional mortgage because of previous credit problems.
Typical Application Requirements for Hard Money Loans
Applying for this type of financing is quite different than what you may have experienced with a standard bank loan. With a conventional loan application, there are often lengthy forms to fill out, strict credit requirements to meet and all sorts of financial documents to submit. Then, you have to sit back and wait over a month to find out if you’re approved.
When you apply for a hard money loan, you’ll have to complete an application and agree to a credit check just as you would with any other type of financing. But while hard money lenders do look at your credit score, they’re usually not terribly concerned about credit blemishes like recent short sales and foreclosures, or details like the length of time you’ve been in business or your cash flow. With a hard money loan, the main factors lenders consider are the value of the property you’re borrowing against and the amount of funds you’re putting into the project. Depending on your lender’s application process, the slim list of documents you have to submit may include:
- Two to three months of bank statements
- Details of your previous experience and completed projects
- The property purchase contract and comparisons
- A property inspection report, renovation estimate and expected time frame
- Proof that you have the funds available to contribute
- Details of your loan exit strategy, such as selling the property or refinancing to a conventional mortgage
Some lenders may order an appraisal to learn the value of a property. Some may also have a minimum credit score requirement for applicants, which can range from 550 to 640.
How Much You Can Borrow and How Long Funding Takes
The amount you can borrow with a hard money loan is based on the same factors as getting your application approved, such as your creditworthiness, previous experience with real estate investing, equity contribution and the value of the property you’re using as collateral. While some lenders will want a full appraisal done, others rely on a faster, less in-depth real estate broker valuation to judge the property’s worth. Once a lender has all the details they need about you and the real estate in question, they’ll determine how much you can borrow in one of two ways:
- Loan-to-value (LTV) ratio. The LTV ratio is the amount you need to borrow divided by the property’s value. For example, if you need to borrow $160,000 and the property you’re buying is valued at $200,000, the LTV ratio would be 80%. The percentage a lender may give you can range from a low of 65% to as much as 90% of the property’s current value.
- After repair value (ARV). To get the ARV on a property, you simply add together the real estate’s present value or purchase price and the amount you plan to spend on renovations. Loans based on ARV cost more because they require less borrower equity, and lenders typically approve a lower percentage based on ARV compared to LTV. For instance, a lender may give you 80% of a property’s LTV but only 65% of its ARV.
Based on factors like those mentioned above and your lender’s approval guidelines, you may be able to borrow up to $5 million with a hard money loan. Depending on the lender you’re dealing with, your loan may get approved in just a day or two, and you could have the borrowed funds in your bank account within 5 to 15 business days. Hard Money Loan Payback Terms
The terms of hard money loans can vary a lot depending on the lender and the borrower’s purpose for the real estate. A fix-and-flip buyer may only need a 12-month term, while a rental property investor may be looking for a 30-year loan. Most hard money loan terms range from one to five years. Some loans can have no or interest-only monthly payments required with a balloon payment at the end of the term that pays off the principal, any remaining interest and loan fees. Others may require monthly interest and principal payments similar to a conventional loan.
Costs of Borrowing Hard Money
Because the credit requirements aren’t as strict with this type of financing, the lender is taking a bigger risk that you’ll default. This is why, as a general rule, you can expect to pay higher costs for a hard money loan compared to traditional bank financing. However, the different costs of borrowing are the same as with a standard loan and include interest, lender fees (also called points), closing costs and, in some cases, appraisal fees. What you pay for each item depends on the lender you work with, the amount you put down on the property, how much you borrow and for how long. As a general guide:
- Interest rates can vary from 4.8 to 13% or higher for longer-term hard money loans, and 10% or more for shorter-term bridge loans.
- Lender fees can range from 1.5 to 5% of the loan amount.
- Closing costs can be up to 5% of the amount borrowed with some lenders, while other lenders charge a flat closing fee.
- Appraisal fees can add $300 to $500 or more to the costs, if a lender requires one.
Depending on the lender, you may be able to get a lower interest rate if you have a higher down payment. Some lenders charge a prepayment penalty if you pay off the loan before the end of the agreed term to help recoup some of the interest they’re losing.
Example of Hard Money Loan Upfront Costs
- Loan amount: $500,000
- Term: 12 months
- Interest rate: 7%
- Lender Fees: 2% or $10,000 (0.02 * $500,000)
- Closing Costs: 1.5% or $ 7,500 (0.015 * $500,000)
- Appraisal Cost: $500
In the above scenario, the borrower incurs $18,000 in costs before they have access to the funds. Oftentimes, upfront costs are taken off the top of the loan amount, which in this instance would leave the borrower with $482,000 to complete their project.
The Pros and Cons of Hard Money Loans
Just like other kinds of financing, hard money loans have advantages and drawbacks. To help you determine if this is the right funding solution for your situation, here’s a look at thepros and cons:
Hard Money Loan Pros
- Easy application process. Most hard money lenders have an uncomplicated application process that doesn’t involve filling out endless forms or sending in reams of financial documents.
- Less concern with credit history. Approval for hard money loans is largely based the value of the real estate and the amount you’re putting down on the property. This can make financing possible if you have less-than-perfect credit.
- Fast access to funding. A hard money loan gives you access to cash in just a week or two, so you can make an offer on an investment property with confidence and close quickly.
- Flexible repayment terms. These loans are offered by private lenders who can offer more flexible payment terms. You may have no payments to make or only interest to pay each month until you’re ready to sell your rehabbed flip or refinance to a long-term mortgage on your new rental property.
Hard Money Loan Cons
- Higher borrowing costs. The hard money loan perks of less strict credit criteria and faster funding typically come with higher interest rates, lender fees and closing costs.
- Shorter payback terms. While a few hard money lenders offer lengthy loan terms, most focus on short-term financing of one to five years. This can mean having to sell or refinance a property in the near future.
- Less government oversight. The lack of government regulations on the hard money loans used to finance investment properties leaves the door open for shady lenders to take advantage of inexperienced borrowers.
Can You Benefit from a Hard Money Loan?
Do you need cash to buy a fix-and-flip property, add to your rental portfolio or purchase other investment real estate? If so, a hard money loan may be the ideal financing tool to let you snap up an available property and cover the cost of renovations. You’ll pay more for this type of loan, but the hassle-free application process, limited credit requirements and speed of funding can make the extra expense worthwhile.
Ready to Start Your Search for a Hard Money Lender?
Finding a hard money lender who offers the right terms for your investment project can be time consuming and challenging on your own. At Lendzi, we have the industry knowledge and experience to match you with reputable hard money lenders who meet your exact needs. Our custom approach to financing offers big benefits including an uncomplicated application process, clear cut terms and flexible borrowing choices. Fill out our application online or contact us today for expert help!