What Is a Hard Money Loan in Real Estate?
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Richard Haddad Managing EditorRichard Haddad is the managing editor of HomeLight.com. He works with an experienced content team that oversees the company’s blog featuring in-depth articles about the home buying and selling process, homeownership news, home care and design tips, and related real estate trends. Previously, he served as an editor and content producer for World Company, Gannett, and Western News & Info, where he also served as news director and director of internet operations.
At HomeLight, our vision is a world where every real estate transaction is simple, certain, and satisfying. Therefore, we promote strict editorial integrity in each of our posts.
Are you considering a hard money loan to fast-track your next real estate investment? Whether you’re planning to flip a house or purchase a rental property, a streamlined hard money loan can be a helpful option.
These loans offer a unique financing solution, especially for those who might not qualify for traditional financing due to various reasons, such as a brief project timeline, limited upfront cash, or credit challenges.
If you’re not a professional investor but looking for a solution to bridge the buy-sell timing gap, we’ll also share an innovative way to tap into your home’s equity, allowing you to buy before you sell.
Here’s what you need to know to determine if these types of loans align with your investment and home-buying goals.
Start Making Offers Without Waiting to Sell Your Home
Through our Buy Before You Sell program, HomeLight can help you unlock a portion of your equity upfront to put toward your next home. You can then make a strong offer on your next home with no home sale contingency.
Editor’s note: This post is for educational purposes and is not intended to be construed as financial advice. HomeLight always encourages you to consult your own advisor.
What is a hard money loan?
A hard money loan is a type of short-term financing used in real estate transactions where speed and flexibility are more critical than the cost. The word “hard” in the phrase “hard money” refers to the requirement that the borrower have a tangible asset that acts as collateral to secure the loan.
This means approval relies heavily on the property’s potential and less on the borrower’s creditworthiness. As such, hard money loans can be an excellent resource for house flippers looking to purchase, renovate, and quickly sell a property at a profit. They are also a common financing solution for investors buying rental properties.
As with any secured loan, if a borrower defaults on a hard money loan, the lender can take ownership of the asset — such as a house — to make up for any losses.
How does a hard money loan work?
Here’s a quick overview of how hard money loans typically work:
- Short-term loan: These loans have a shorter repayment period of 6-24 months, compared to a traditional 15- or 30-year fixed mortgage loan. Some lenders will allow a 12-month extension to give borrowers a combined 3-year term.
- Faster funding option: When a property purchase needs to happen quickly, a hard money loan can be approved in a few days rather than the 30 to 50 days it typically takes to complete a mortgage loan.
- Less focus on creditworthiness: Approval is not as heavily dependent on the borrower’s income or credit scores and history.
- More focus on property value: This type of loan requires collateral, such as a home, to secure the loan and is focused on the ratio of the loan amount to the value of the property.
- Not traditional lenders: These bridge loans are generally issued by individual investors or private lending companies rather than traditional banks.
- Loan denial option: A hard money loan is often used by borrowers with poor credit who have been denied a mortgage application but have significant equity in their property.
- Higher interest rates: Because the lender is exposed to more risk, hard money loans are typically more expensive than traditional mortgage loans. (See cost section below.)
- Might require larger down payments: In some cases, borrowers may need a larger down payment, which may be as high as 20%- 30%, depending on the property’s value and the loan circumstances.
- More flexibility: Hard money loans have less government oversight and regulation, allowing lenders to set more flexible credit score and debt-to-income (DTI) ratio criteria. They can also be used as a way to avoid foreclosure.
- Potential for interest-only payments: Unlike a traditional mortgage, a hard money lender may allow you to initially make interest-only payments or arrange for deferred payments.
Hard money loan example
Imagine you’ve found a run-down property in a promising neighborhood and plan to renovate and sell it for a profit. The purchase price is $150,000, and renovations are estimated at $50,000. Traditional banks are hesitant due to the property’s condition, but a hard money lender sees the potential for a high resale value. They agree to lend $180,000, which covers most of the purchase price and some renovation costs, at an interest rate of 12% with a 12-month term. This quick financing allows you to start renovations immediately and sell the property within a year for a significant profit.
What are hard money loans used for?
Hard money loans serve various purposes in the real estate market, catering especially to those needing quick funding or those who might not qualify for conventional loans.
Here’s how they are typically used:
Flipping a house
For real estate investors focused on flipping homes, hard money loans provide fast access to capital needed to purchase and renovate properties quickly. Since these loans can be arranged much faster than conventional loans, flippers can snatch up properties in competitive markets, make necessary improvements, and resell for a profit, all within a short timeframe.
Buying an investment rental property
Investors looking to purchase rental properties may use hard money loans to secure a property swiftly, particularly if it requires immediate repairs before it can generate rental income. These loans allow investors to renovate and rent out properties faster than if they went through traditional banks.
Purchasing commercial real estate
Commercial real estate transactions often use hard money loans due to their flexibility and the speed with which they can be executed. They can be pivotal in commercial deals where timing and the ability to act quickly can make or break the investment.
Borrowers who can’t qualify for traditional loans
Borrowers who hold substantial equity in a property but may have poor credit or other issues that disqualify them from traditional financing often turn to hard money loans. These loans focus more on the asset’s value rather than the borrower’s credit history.
Homeowners facing foreclosure
Homeowners in foreclosure or near foreclosure may seek hard money loans as a last resort to refinance their debts or buy time to sell the property. This can provide a temporary solution to avoid losing their property or having a foreclosure attached to their credit report.
How much do hard money loans cost?
The cost of hard money loans is typically higher than traditional loans due to the increased risk lenders undertake, and the convenience of quick, less restrictive funding. Here are some typical costs associated with hard money loans:
- Interest rates: These can range from 8% to 15% or higher, depending on the lender’s risk assessment.
- Origination fees: Lenders may charge 1% to 5% of the total loan amount as an origination fee.
- Closing costs: Additional fees at closing can include legal fees, appraisal fees, and other administrative costs.
- Points: Lenders might charge points (a percentage of the loan amount) upfront, which can add to the initial cost of obtaining a loan.
There are many hard money loan calculators available on the Internet to give you an idea of your costs.
Pros and cons of hard money loans
Hard money loans can be a valuable tool for certain real estate transactions, but they come with distinct advantages and disadvantages.
Pros
- Speed: The most significant advantage is the speed of funding. Hard money loans can be processed in days to weeks, unlike traditional loans, which can take months.
- Flexibility: These loans offer more flexibility in terms of the agreement and repayment terms, which can be tailored to fit specific project needs.
- Accessibility: For those unable to secure traditional financing due to credit issues or other financial challenges, hard money loans provide an alternative path to pursue real estate ventures.
Cons
- Cost: The biggest drawback is the high cost. Interest rates and fees are considerably higher than those of traditional loans.
- Short repayment period: These loans often require repayment within a short timeframe, which can be risky if the real estate project does not proceed as planned.
- Property as collateral: If the loan cannot be repaid, the lender may seize the property, which poses a significant risk to the borrower.
Examples of hard money loan lenders
According to business.org, here is a list of some of the top U.S. companies that offer hard money loans:
- Flip Funding
- Groundfloor
- Kiavi
- Residential Capital Partners
- CoreVest
- Sherman Bridge
- Lima One
- RCN Capital
- Lending One
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Alternatives to hard money loans
For those considering alternatives to hard money loans, here are a few other options:
- Take out a second mortgage: If you have significant equity in your home, a home equity loan or a home equity line of credit (HELOC) might provide the necessary funds at a lower interest rate than a hard money loan.
- Cash-out refinance: A cash-out refinance may be a more affordable way to pull cash out of another property and use the money to finance your investment purchase.
- Borrow from family or friends: A personal loan from family or friends can offer more flexible repayment terms and potentially lower or no interest rates.
- Use a government-backed loan program: Programs like those offered by the FHA, VA, or USDA can assist with buying homes, often with lower down payments and reduced interest rates.
- Peer-to-peer loan: This type of loan is provided by an individual investor — a “peer” in the industry. It functions similarly to a hard money loan and can be initiated through a lending platform like MeridianLink or Funding Circle.
- Specialized loan programs: For alternate financing, or if you already have a hard money loan and want to replace it, you might consider specialized fixer-upper or investment property refinance loans.
- Request a seller financing option: In some rare cases, sellers may agree to finance the purchase themselves, typically resulting in lower closing costs and potentially less stringent eligibility requirements.
How to buy before you sell
If you are a homeowner trying to solve the age-old buy-sell timing conundrum, there is now a modern way to buy before you sell.
HomeLight’s Buy Before Your Sell program makes it easy to use the equity from your existing home to make a stronger, less contingent offer on a new property. Our innovative program, with its near-instant Equity Unlock Calculator, lets you streamline and simplify the entire buying and selling process.
Here’s how HomeLight Buy Before You Sell works:
If your home qualifies, you can get your equity unlock amount approved in 24 hours or less. No cost or commitment is required. Once you’re approved, you can buy your next home with confidence and then sell your current home with peace of mind.
»Learn more: How to ‘Buy Before You Sell’ with HomeLight
FAQs about hard money loans
Without proper planning, these loans can be risky. The higher interest rates and the short repayment periods increase the financial burden and risk. If the investment does not turn out as planned, there’s a significant risk of losing the property. With a hard money loan, it’s important to have a solid exit strategy.
Using a hard money loan to purchase a primary residence is generally not advisable due to the high interest rates and short repayment terms associated with these loans. They are primarily designed for investment opportunities with a quick return, such as flipping houses or purchasing rental properties. For a primary residence, where long-term affordability and stability are key, considering more traditional and less costly financing options might be more beneficial. You might also consider a buy before you sell program. However, if you find yourself in a unique situation where quick financing is crucial, and you have a clear, rapid repayment plan, it could be considered as a last resort.
Hard money loans are usually short-term, typically ranging from 6 months to 3 years, which can be ideal for projects expected to return profits quickly.
Yes, most hard money lenders require a down payment, which can range from 20% to 30% of the property’s purchase price, depending on the project’s risk assessment.
To find a reputable lender, start by seeking referrals from industry professionals, such as a top real estate agent in the area. Be certain to check lender credentials and histories, and review terms carefully. Always ensure they have a legitimate track record and clear, fair loan agreements. You can also check customer reviews on sites like BBB.org.
Payments are typically interest-only on a monthly basis, which means you don’t pay toward the principal loan each month. At the end of the loan term, you’ll be required to pay back the full principal amount. This can vary based on the lender and your specific agreement.
The primary requirement is sufficient equity in the property (hard asset) you are financing. Lenders will also consider your plan for the property and your financial history, though not as extensively as a traditional bank would.
While credit scores are considered, they are less critical in hard money lending than in traditional financing. Lenders focus more on the property’s value and the borrower’s equity in the property.
Is a hard money loan right for me?
Deciding whether a hard money loan is right for you depends on your specific circumstances and investment goals. These loans are best for projects that need a quick turnaround or when traditional financing is not an option. If you are prepared to handle the higher cost and shorter repayment terms in exchange for rapid, flexible funding, a hard money loan might be the right tool to finance your next real estate investment venture.
As with any financial decision, consider your long-term strategy and consult with a financial advisor to ensure it aligns with your overall investment goals.
If you’d like to speak with a top real estate agent in your area who has connections to trusted hard money lenders and other local insights, HomeLight can connect you with the highest-rated agents in your community.
If you’re a homeowner just looking to make a strong offer on a new house, consider HomeLight’s Buy Before You Sell program to unlock the equity in your current home.
Header Image Source: (mgattorna/ Pixabay
- "How to Refinance a Rental Property", U.S. News (January 2024)
- "What Is Peer-to-Peer Lending?", Business.org (July 2022)
- "What is a home equity line of credit and how can it help you?", CNBC (August 2023)
- "What are Points on a Hard Money Loan?", LinkedIn (December 2021)
- "7 minute read January 26, 2022 Hard Money Loans What are the Closing Costs of a Hard Money Loans?", Marquee Funding Group (January 2022)
- "debt-to-income ratio", Legal Information Institute (July 2021)
