Hard Money Loans 101: Hard Money Loans For Beginners

When people consider options to finance a real estate purchase, they may start by looking at mortgages. However, there are other types of funding, including hard money loans. Hard money loans offer a different type of lending experience, aimed primarily at investors but also available to homebuyers in certain cases. Since these loans are significantly different from mortgages, it is vital that potential borrowers understand these differences. By learning how a hard money loan works and the primary use of these loans, borrowers can decide which financing is best for their projects.

What Is a Hard Money Loan?

A hard money loan is a loan from a private lender that typically does not conform to conventional lending standards. The term "hard money" refers to an older practice of using items with intrinsic value as currency. While most people think of cash as being intrinsically valuable, coins made of copper, silver, or gold actually hold value. People may refer to hard money loans as:

• Private money loans
• Bridge loans
• Construction loans
• Rehab loans
• Short-term loans
• Asset-based loans

There is a degree of overlap in these terms, but they are not always the same thing.

Hard Money Loans vs. Conventional Mortgages

Hard money loans and conventional mortgages are quite distinct. They have unique requirements for down payments, underwriting, interest rates, and terms. People should understand the differences before choosing one or the other for a real estate purchase.

Hard Money Loan Requirements Are Different

The requirements to get a hard money loan are almost entirely different from a conventional mortgage. Specifically, when people apply for a conventional mortgage, they are typically meeting requirements set by Fannie Mae or Freddie Mac, which are government-run organizations that set loan standards for lenders to offer in conforming loans. These standards typically focus on a person's ability to afford a primary or secondary residence. In order to qualify, applicants usually need to meet a particular credit score, debt-to-income ratio, and ability to repay.

By comparison, hard money loans are almost exclusively focused on the value of the property in question. Aimed primarily at investors instead of buyers looking for a home, these loans require an evaluation of the property, the loan-to-value, as well as the investor's plan to build, renovate, or remodel it. Aspects like credit score, income, or debts may factor into the decision, but not as much as they would for a conventional mortgage. Hard money lenders have a greater amount of flexibility in determining requirements, which can make these loans faster to process and easier for certain people to get.

Down Payments on Hard Money Loans

Because hard money loans are typically not owner-occupied, the down payments are usually higher than they would be for a conventional mortgage. People who want to get a conventional mortgage may plan to put a 20% down payment as a way of avoiding private mortgage insurance. Several mortgage programs allow people to qualify with a down payment as low as 3%. This variability exists because primary residences act as the biggest incentive to keep homeowners paying the mortgage.

By comparison, hard money loans usually require a minimum down payment of 25–35% of the sale price. Some lenders calculate the total value they will provide based on the estimated future value of the property, while others focus on the loan-to-value ratio. In either case, the larger down payment provides a greater assurance to the lender that the borrower has a stake in the property.

Hard Money Loan Interest Rates

As a loan with a higher degree of risk, hard money loans also have higher interest rates. Borrowers who apply for hard money loans do not have access to some of the programs that homeowners with conventional mortgages have if they struggle to make payments. Hard money lenders also spend less time investigating a borrower's creditworthiness, which increases the risk of default.

Lenders address this risk in the form of interest rates that are 2–10% higher than a conventional mortgage. Rates depend heavily on the region, since a lot of competition in one area may drive down the rates. Lenders are not bound by the same lending standards for conventional mortgages. This means that the interest rates on hard money loans may be significantly higher, depending on the application.

What Are "Points" in Hard Money Loans?

Hard money loans usually include points, which act as origination fees. In essence, when providing a loan, the lender charges a set percentage of the loan as a fee to process it, provide the funds, and service the loan until the end of its term. In most cases, the number of points that borrowers have to pay ranges from 2–5% of the loan amount. Someone who wants to borrow $250,000 with a loan that charges two points would need to provide an additional $5,000 on top of the down payment.

Timescale of Hard Money Loans vs. Conventional Loans

The difference in processing time sets hard money loans and conventional mortgages apart. When a home buyer applies for a mortgage through a bank, credit union, or other conventional lenders, they may spend weeks waiting for underwriting to process the application. This time allows the lender to process the extensive number of documents provided by the applicant, ask for explanations on important factors, and provide the borrower with sufficient time to review the terms of the loan and make a decision.

Hard money lenders focus primarily on the value of the property and the investor's project. For investors who already have a detailed plan in place, the underwriting process can take significantly less time. Specifically, while processing a mortgage usually takes about a month, hard money loans could take only a few days.

Example Hard Money vs. Conventional Loans

Once people compare the terms of these loans, the differences may become evident. A $500,000 mortgage might require a 3% down payment, which is $15,000. The interest rate ranges from 3–5%, depending on the borrower's creditworthiness and the loan term. With a fixed-rate loan, the borrower pays the same amount each month for principal and interest, typically for a term lasting 30 years. The processing time takes 30 to 45 days.

For a similar hard money loan, a borrower seeking a $500,000 loan would be expected to pay $125,000-$175,000 as a down payment, along with $10,000-$25,000 in points. The loan processes much more quickly, a week in most cases. The borrower may pay interest-only or a combination of interest and principal, with an interest rate of 7–12%. Typically, the borrower will refinance or make a balloon payment at the end of the term, which lasts 6 to 18 months.

What Are Hard Money Loans Used For?

Hard money loans tend to be used in certain types of real estate purchases. Specifically, investors commonly use hard money loans because the quick approval and short term give investors the time they need to secure the purchase, make necessary renovations, and refinance or sell.

Fix-and-Flip Buyers

Many real estate investment businesses focus on purchasing properties, remodeling them to meet current buyer preferences, and selling them as quickly as possible. This process is commonly referred to as fix-and-flip, and most people aim to complete the process in less than six months. Since buyers are usually not looking to live in the house, they are often not seen as good candidates to apply for a conventional mortgage.

Experienced flippers who work on multiple properties at once may have too much debt to qualify for a mortgage, making rehab loans more appropriate. They can:

• Find a property
• Apply for a hard money loan
• Process the loan in a few days
• Purchase the property
• Take a draw from the loan to cover rehab expenses almost immediately

Once they sell, they can repay the hard money loan before the end of its term.

Investment Properties

Buying investment properties often requires the ability to act quickly, especially in regions with a hot real estate market. Investors who plan to flip homes need to find properties that are priced well below market value without representing a high cost to rehabilitate. Investors may be competing with other investors or homebuyers, who are often ready to pay cash for the property and close within a few days.

The quick processing time of a hard money loan allows investors to get financing for the property without necessarily spending too much time on the financing process. Lenders with experience in the type of real estate may be able to make a decision within 24 hours, allowing the investor to take advantage of a deal before someone else does.

Hard Money Loans for Bad Credit

Since hard money loans look at different requirements for qualification, they may be an option for people who do not meet the standards needed to get a traditional mortgage. For the most part, borrowers have to achieve a specific credit score or income level to get a mortgage. People who have lower credit scores, limited credit histories, or income that is difficult to prove may have fewer options in getting a loan.

Hard money loans are popular for investors, but they may also work for self-employed people. As a general rule, homebuyers who want to get a hard money loan need to have significant assets and a high income, even if it comes from a business or an inconsistent source. Once they own the property, they may have more options to refinance the hard money loan into a mortgage when the term ends.

Bridge Loans

Bridge loans are short-term loans intended to allow a person to buy a property, build on it or remodel, and refinance before the end of the loan. These loans can come from conventional lenders, but they are a popular choice from hard money lenders as well. Typically, investors will follow a similar process:

• Identify a piece of land or a property that they want to buy
• Apply for a hard money loan
• Use the loan to purchase the property and complete construction
• Refinance the loan into a conventional mortgage

Many types of buyers use bridge loans. Investors apply for bridge loans if they need to renovate a property they plan to hold or are buying a rental property. Homebuyers could get a bridge loan to help them rehabilitate or rebuild a primary residence. The hard money loan makes it convenient to get funding fast, which they can later convert into a mortgage to pay off over a longer period of time.

Dodd-Frank and Owner-Occupied Hard Money Loans

In 2010, Congress passed regulations intended to protect consumers from certain lending tactics. As part of this legislation, lenders are required to perform extra vetting to confirm that borrowers can afford to pay the mortgage, and that they understand the terms of the loan. This legislation can significantly complicate the hard money loan process for consumers, which is why many hard money lenders do not offer loans for consumer owner-occupied properties.

Consumer Owner-Occupied Loans vs. Business Owner-Occupied Loans

The Dodd-Frank Act set requirements that lenders had to follow to offer mortgages to consumers who wanted to purchase a primary residence. The chief premise of the legislation stemmed from the belief that borrowers did not necessarily understand the terms of the loan and that some lenders were not confirming that the borrowers could repay it before approving the loan. The law applies specifically to purchases of owner-occupied residential properties. Hard money lenders who offer these loans must spend extra time verifying a borrower's credit and allowing them time to review the loan. As a result, many hard money lenders do not offer them.

Many popular features of a hard money loan, like quick closing or limited personal qualifications, apply only to non-owner-occupied properties or business owner-occupied properties. Businesses can access many of these benefits, even if they plan to hold and use the property as opposed to renovating and selling it. Applicants should plan to confirm with a hard money lender about the types of loans that they offer. Some lenders specialize or may limit their services only to non-owner-occupied properties.

Pros and Cons of Hard Money Loans

In order to make a decision, people have to evaluate the pros and cons of hard money loans. By looking at each, it may be easier for people to determine if a hard money loan is an appropriate choice for their real estate purchase plans.

The Benefits of Hard Money Loans

With a more flexible process for originating and underwriting loans, hard money lenders offer a number of benefits. These include:

• Flexible terms, tailored to the loan in question
• Fast preapproval, in as little as 24 hours
• Loan requirements based on the property, not the borrower
• Loan amounts that are not dependent on conforming loan standards
• Quick closing, ranging from 3 to 10 days in most cases
• Timely disbursement of funds within 48 hours of a draw

Many of these features are dependent on the lender and the competition in the area. It also depends on the way that the borrower wants to use the loan. Lenders may have different rates and terms for separate hard money loan programs. People should plan to shop around to confirm that they can get the best deal.

The Drawbacks of Hard Money Loans

Hard money loans may have some drawbacks that applicants should consider before they borrow money. These include:

• Larger down payment, typically 25–35% but could be as high as 50%
• Higher interest rates, ranging from 6–14% in most cases
• Higher origination fees, usually 2–5% of the loan value
• Limited options for owner-occupied properties, especially for consumers
• Short payment terms of 6 to 18 months, occasionally up to five years

People who intend to rely on the flexible approval standards of a hard money loan may have fewer options to refinance, especially if they plan to hold or rent out the property. Hard money loans often have balloon payments at the end, which may be difficult for investors to pay if they have not been able to secure other funding.

How to Choose a Hard Money Lender

Choosing a hard money lender requires some research. Borrowers want to be sure that the lender is equipped to provide the money at the right time and likely to be a reasonable partner in the financing arrangement. People may want to look for hard money lenders with the following:

• Experience in the type of real estate they want to buy
• Knowledge of the needs and expectations of the local real estate market
• A good reputation among investors in the area
• A history of quick closing, especially in hot real estate markets
• The ability to approve the necessary loan value
• A track record of timely disbursements

Lenders who have licensed real estate professionals on staff can help to establish credibility. In some regions, people may have many different lenders to choose from. They should consult several to see which one is the best fit.

How to Turn a Hard Money Loan into a Conventional Loan

The way to turn a hard money loan into a conventional loan depends on the borrower and their plans for the property. It is a common process, particularly for people who decide to hold a property or rent it out. In this case, investors will apply for a mortgage to buy an investment property. They may have different requirements to qualify than someone planning to convert a hard money loan into a mortgage for an owner-occupied property. The differences commonly include a higher interest rate and more significant assets in reserve.

For people who want to turn a hard money loan into an owner-occupied property, converting the mortgage may require a full application process. As a part of qualification, applicants will likely need to prove that they meet credit score, income, and debt requirements. Some lenders offer short-term to permanent loans with an automatic conversion, but these are less common.

Finding the Loan That Works Best For You

Choosing the right kind of financing for a real estate purchase can be complicated. These complications can affect investors in particular, as well as borrowers who do not fit the typical requirements to qualify for a mortgage. In these cases, people may want to look for options outside of conventional mortgages for financing, including hard money loans. Hard money loans offer many benefits but also important considerations for borrowers, since they are so different from mortgages. By comparing the details and shopping around for the right lender, borrowers can make the choice that will work best for them.

Additional Reading

• https://www.investopedia.com/terms/h/hard_money_loan.asp
• https://www.rocketmortgage.com/learn/hard-money-loans
• https://www.quickenloans.com/learn/hard-money-loans
• https://www.thebalance.com/hard-money-basics-315413
• https://nwprivatelending.com/faqs/conventional-versus-hard-money-loan/
• https://www.forbes.com/sites/forbesbusinesscouncil/2021/07/13/3-pros-and-cons-when-borrowing-hard-money/?sh=556137f395e3
• https://www.longhorninvestments.com/how-does-hard-money-lending-differ-from-conventional-lending/
• https://loanrangercapital.com/what-you-need-to-know-about-hard-money/
• https://www.forbes.com/sites/forbesbusinesscouncil/2021/05/12/what-is-hard-money-in-real-estate-investing-and-how-does-it-work/?sh=7fb298ac33d7
• https://retipster.com/hard-money-101-everything-need-know-getting-started-hard-money-loans/
• https://www.investopedia.com/terms/h/hardmoney.asp
• https://www.forbes.com/sites/forbesbusinesscouncil/2021/05/12/what-is-hard-money-in-real-estate-investing-and-how-does-it-work/?sh=1f4d5c9733d7
• https://www.millionacres.com/real-estate-financing/hard-money-loans/hard-money-loans-guide/
• https://www.investopedia.com/terms/b/bridgeloan.asp
• https://listwithclever.com/real-estate-blog/6-things-to-know-about-owner-occupied-hard-money-loans/
• https://marqueefundinggroup.com/top-3-benefits-of-owner-occupied-hml/
• https://www.forbes.com/sites/forbesbusinesscouncil/2021/07/13/3-pros-and-cons-when-borrowing-hard-money/?sh=601d258895e3
• https://www.millionacres.com/real-estate-financing/articles/how-do-you-refinance-a-hard-money-loan/
• https://www.millionacres.com/real-estate-financing/hard-money-loans/hard-money-loans-guide/ (the down payment percents seem off but this is what made me think origination fees are the same as points)
• https://marqueefundinggroup.com/owner-occupied-hard-money-loan/
• https://listwithclever.com/real-estate-blog/6-things-to-know-about-owner-occupied-hard-money-loans/ (I believe the 10-day thing Marquee Funding Group is referring to is the mandatory recission period referenced here)
• https://www.tidalloans.com/how-to-refinance-out-of-hard-money-loan/ (temp to perm loans)
• https://www.forbes.com/sites/forbesbusinesscouncil/2021/07/13/3-pros-and-cons-when-borrowing-hard-money/
• https://geracilawfirm.com/dodd-franks-effect-on-hard-money-lending/
• https://www.longhorninvestments.com/how-to-choose-a-hard-money-lender/