When it comes to purchasing a piece of property, most people only know of one option: going to the bank and applying for a mortgage. However, if you’re more interested in investing in real estate and not just owning a home, there is another option that they should consider. Instead of visiting the bank, you can visit a private lender and apply for a hard money loan.
Hard money loans can be advantageous depending on the type of investment you’re making. That being said, there are pros and cons to all financing options.
This article will explore hard money loans: how they work and who they are best suited for.
What is a hard money loan?
Hard money loans are defined as alternative types of loans used to buy real estate. These loans are generally offered by private companies, not banks, which means that things like rates, fees, terms, and other procedures are often based on that particular lender’s preferences.
Pros of hard money loans
Hard money loans are generally used by people who need an alternative to a traditional mortgage or are more interested in investing in real estate instead of long-term ownership.
Let’s look at a few of their advantages:
- Easier to get approved – Since you’re dealing with a private institution, you don’t have to deal with traditional vetting methods used by banks (credit checks, debt-to-income ratios, etc.)
In fact, usually, the property itself serves as collateral for the financing so lenders will look past a questionable financial history or other risk indicators.
- Short-term lengths – The standard term length for a hard money loan is about 6 months. This is ideal if your plan is to buy and flip the property quickly.
- Quick approval – Hard money loans can be approved in as quickly as a few days. Compare this to a traditional mortgage, where it can sometimes take up to a month to get approval.
Due to the short term nature of these loans, they can be ideal for investors who want to buy a property, invest a little money to fix it up, and then sell it at a significant profit. They’re also a good starting point for investors who might not have the financial credentials required from banks.
Now let’s take a look at a few cons.
Cons of hard money loans
As we mentioned, there is no perfect option for financing and the best option generally depends on the situation. Let’s explore a few of the potential cons of using a hard money loan:
- Lower loan-to-value ratios – Hard money loans use the property itself as the only protection against default. This means that they generally have LTV ratios of around 50% to 70%, vs. 80% for regular mortgages.
- Higher rates of interest – The average interest rate for a hard money loan is usually around 7-15%. Compare this to just 4-6% for a traditional mortgage.
- Less standardized – Because you’re dealing with a private lender, it’s more important to do your own due diligence on all properties that you want to buy. If you are unable to meet your loan payments then you may have to give up ownership of the property.
We hope that you’ve found this article valuable when it comes to understanding how hard money loans work!