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What is a Hard-Money Lender, and When To Use One

Authored By: 
Andrew Goodwin

Hard money lenders are private lenders (individuals or companies) that offer short-term loans, which are secured on the quick-sale value of a property owned by the borrower. 
 
The rate of interest on these loans is higher than rates charged by banks and this is because:
  1. The borrower’s financial condition is such that his loan application will be rejected by the bank, and
     
  2. The hard money lender takes a risk in advancing funds to a potentially risky borrower.

The interest rates on hard money loans can range between 10% and 18%, but defaulting borrowers can be charged higher rates. Some lenders require borrowers to make monthly interest payments while some defer interest payment to payoff day.

Interest rates and payment depends on the term of the loan, borrower’s risk profile, the value of the property and the current real estate market situation. For example, if there are many home foreclosures in the area, then the real estate market will be muted and the hard loan rate of interest will be higher because the lender will have to try very hard to sell the property in case of a default.

These charges and rates are understandable because the borrowers cannot get loans from conventional sources, which is why they opt for a hard loan. If you were to invest your hard-earned cash in a very risky venture, you would naturally expect high returns, wouldn’t you? Another reason why hard lenders charge a higher rate of interest is because consumer protection laws and expensive and time-consuming legal cases have pushed lenders into creating punitive terms.

Hard loans are usually given for between 3 and 12 months to tide over a situation or to grab an investment or profitable opportunity, but can also be given for up to 5 years depending on the situation. Longer loan terms are given at higher rates of interest. Hard loans are literally available “off the shelf” and can also help borrowers easily “bridge” over a tough situation.

How are hard loans structured?

Hard lenders structure loans based on the following criteria:

  • The Loan-to-Value (LTV) percentage. The lenders estimate the market value of the property and advance a loan based on what could be realized if the property was sold within 1-6 months from the date of funding the deal. This value is referred to as the quick-sale value. Lenders typically advance up to 70% against the quick-sale value of the property. The quick-sale value of a property differs from a market appraisal, which does not take distress sale value into account.
     
  • Type of borrower – lenders advance loans to businesses and individuals. Each borrower’s risk profile is assessed before the loan is given.
     
  • Minimum loan size.

Hard Loans FAQ

1. Are hard loans evil as they are made out to be?

Well, no. The rate of interest on a hard loan is marginally higher than the interest rate on a credit card. So, if you are a responsible borrower, you have nothing to fear.

2. How long does it take to obtain a hard loan?

You can get one within 72 hours so long your papers are clear.

3. What are the hard loan costs?

You have to pay the property appraisal fees. You also have to pay for Title Policy and insurance.

4. Does the lender check my credit score?

Not necessarily. But he will check your credit to determine if you have been involved in bankruptcy, foreclosures, short sales, collections, etc. He will also check your repaying capabilities. More than anything else, he will turn a hawk’s eye on the property – because that is his collateral and the most important part of the deal. The lender will also ensure that you have enough resources to repay the loan and the interest.

When should I obtain a hard loan?

Hard money lenders are an absolutely indispensable resource for experienced real estate investors. If you ever spot a real estate opportunity that can make you money in the short-term, you must go right ahead and obtain a hard loan. For example, if you come across a house that’s available at a bargain, and you know that if you buy the house and hold it for a couple of months, you will make a tidy profit – then you must obtain a hard loan to finance your purchase.

Let’s suppose you are selling your home and its current market rate is $100,000. Now, you know that if you renovate your home, you will be able to sell it for $200,000. In such a situation, you must opt for a short-term hard loan. Your renovation work will be over soon and you can pocket most of the additional $100,000 in no time!

Businesses that are sitting on lucrative orders but cannot get bank finance also must look at hard loans. Hard loans will give the businesses much-needed working capital, which will in turn help the business execute the order, repay the loan on receipt of sale proceeds, and pocket the windfall.

Property flippers, who buy revenue-bearing properties and quickly sell these at a profit, are also helped by hard lenders. Buy-to-let investors, who buy bare properties, renovate them and let them out, can also opt for hard loans.

Do’s and Don’ts on a Hard Loan

A hard money loan comes with a higher rate of interest and it is available for a short duration. The loan fees are high as well. If you are obtaining a short-term hard loan than you must ensure that the loan fees are not high, else, your benefit/profit may be cannibalized by the high fees, interest, and prepayment charges, if any.

You must be absolutely certain that you have enough resources to repay the loan because you don’t want the lender to foreclose your home because of non-payment. Non-repayment of the loan can also result in a breach of contract lawsuit.

You also must check the lender’s credentials. You don’t want to borrow from a lender who has many complaints registered against him on the BBB. You also must talk to other borrowers to figure out if your lender runs a professional outfit. Some lenders want to receive interest for a specified number of months and such loans carry a prepayment penalty, which you must be careful of. You must shop around for the best rates before settling for a lender.

Finally, the biggest risk associated with hard money lending is the real estate market. If the real estate market crashes, hard money lenders will be left with many homes that have no takers. This will create a setback for the already tottering economy. Borrowers too can lose their homes if they do not repay the loans in a falling market.

Summing Up

To sum up, hard loans really help out the seasoned real estate investor. These loans help maintain the real estate market balance as well. Every buy-to-let landlord, business owner, real estate investor, and borrower in need of a bridge loan, must positively consider a hard loan. That said, you need to carefully plan and strategize your hard loan. You don’t want to be stuck with a high rate of interest and an unnecessary asset in these uncertain times. Also, before obtaining a hard loan you must first try to obtain finance from their banks and resort to hard funding only if you are unable to source conventional finance.

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