What is a hard money loan and when is it used?

When most people think about real estate financing, they think about traditional bank loans. These loans are usually used to purchase a new property or to refinance an existing loan, and they may be available through larger or smaller banks as well as credit unions and other financial institutions. At some point, you may have stumbled across the term hard money loan. Perhaps a mortgage broker recommended that you look into hard money loans, or you may have come across the term through online research. 

Hard money loans are significantly different than the typical real estate loan that you may be most familiar with, so it is important to learn as much as possible about them before you determine if they may be right for your situation. While they are unique, they serve a critical function for many loan applicants. To decide if a hard money is a reasonable financing solution to address your current financing needs, it is necessary to learn more about what they are, how they are used and how they are different from traditional real estate loans. 

Understanding Residential and Commercial Hard Money Loans

Hard money loans can be used with both residential and commercial properties. However, each hard money lender may only accept specific property types, and you should not assume that every hard money lender has a financing option that is suitable for your needs. This is a special type of secured financing that uses real estate as collateral and that has a very short term. The term length is usually around one year long, but there are variations to this. Be aware that the term is rarely more than a couple of years long, but some lenders do grant requests for extensions. 

In addition to the very short term length, there are other substantial differences between hard money loans and traditional bank loans. For example, a hard money loan is funded by a private investor or by a private lending company using its own money. In addition, these loans usually can close very quickly in comparison to a traditional bank loan. You can reasonably expect a hard money loan to close within a few weeks. The interest rate and loan fees are also higher in comparison to traditional bank loans. This difference in pricing between traditional bank loans and hard money loans is substantially related to the fact that hard money loans are used to fund scenarios that traditional banks turn down. 

How Hard Money Loans Are Used

If you are familiar with traditional bank loans, you may be aware of the fact that banks have specific guidelines and that your loan request must fall within set parameters in order to be approved. Hard money lenders do not review loan requests in this way. Each loan request that is reviewed by a hard money lender is examined for its overall strengths and merits. Special situations are considered. In fact, special situations are the norm with hard money loans. These loans are commonly used with residential properties as short-term financing during a flip. They are also used in this same general manner for commercial properties, but the renovations or rehabilitation efforts are usually much more significant. Hard money loans can also be used on commercial properties that have been mismanaged and that have low occupancy and income numbers as a result. Essentially, hard money loans are used to reposition residential and commercial properties so that they are in good condition and perform as intended or desired. However, because hard money loans have a short term and a higher interest rate, applicants need to have an exit strategy in mind. The most common exit strategies include refinancing the hard money loan into a permanent loan or selling the property.

The Benefits of Hard Money Loans

As you can see, hard money loans serve a special purpose. They fill a financial need for applicants whose projects do not qualify for permanent financing from a traditional bank. In addition, they are appealing to individuals who need a quick closing. For example, hard money loans may be used as temporary financing when a balloon payment is due very soon. After all, it may take an additional month or two longer for a traditional loan to be underwritten and approved. The interest rate may not be desirable, but remember that these are short-term loans. Many are also interest-only loans, which means that the payments may be more affordable than you might think.

If you believe that your current loan scenario may work well with a hard money loan, reach out to a few lenders to explore the options. Remember that hard money lenders are private parties, so there are not universal rules that apply to each one. If you get a negative response from one hard money lender, simply keep searching.