Real estate investing has become increasingly popular with the emergence of various sources of financing. Tailored to your needs, you can find the type of financing to enable you to make transactions and integrate further into the real estate market. Whether it is standing loans, traditional, or hard money loans, investing and buying an investment property with little or no money has been made easier.
In this article, we will explore hard or private money loans and how you could use them in financing investment properties, while also comparing them to other financing sources. We will answer the following:
- What Are Hard Money Loans?
- Which Real Estate Investors Benefit the Most?
- What Are the Advantages of Hard Money Loans?
- What Are the Most Common Types of Hard Money Loans?
First, What Are Hard Money Loans?
Hard or private money loans are short-term loans mostly secured for real estate investing. As opposed to conventional loans, hard money loans are secured by private investors. Hard money loans, moreover, tend to have terms of around 12 months. In some cases, however, loan terms can be extended as long as 2 to 5 years. When you take a hard money loan, your monthly payment will compromise of only interest payments on the loan. At the end of the term, you will pay a balloon payment to completely cover and pay off the loan.
What is great about private money loans is that the value of the property determines the loan. While conventional money lenders focus on a borrower’s creditworthiness in order to approve a loan, private investors or hard money lenders, in fact, do not make such a connection. Instead, hard money lenders lend money based on the value of the property that a borrower will buy.
Who Benefits the Most from Hard Money Loans? Why Hard Money Loans?
Hard money lenders give hard money loans to finance both residential and commercial investment properties. What you should note here is that hard money loans do not work in favor of owner-occupied properties. Nor will a hard money loan be used for personal or household use. Hard money loans benefit real estate investors who wish to buy a property, fix it, and sell it within 12 months. Other beneficiaries include long-term real estate investors who purchase distressed properties, renovate them, and rent them to tenants.
The two types of real estate investors benefiting from hard money loans are detailed below:
Fix-and-Flip Investors
A fix-and-flip investment strategy is when a real estate investor purchases a property at a low price (undervalued), fixes and renovates it, and sells it for higher. Because these investors generally operate within a shorter period of time as opposed to traditional investments, hard money loans seem to be a good fit. This is because fix-and-flip investors buy properties, fix and sell them within the terms of the loan. For fix-and-flip investors, hard money loans are equal to a percentage of a property’s after-repair-value (ARV).
It is important to note that during renovations, fix-and-flip investors pay only interest. Once an investor finishes renovating the house and then sells it for profit, he/she will repay the loan.
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Buy-and-Hold Investors
Another type of investment that hard money loans service is buy-and-hold investment properties. Typically, investors use hard money loans when they want to finance an investment property that is in very poor shape. This is because traditional lenders will not issue conventional loans or mortgage for properties that are in poor condition.
When using hard money loans, long-term investors finance the initial purchase price and renovations made to the asset. Once renovations are made, long-term real estate investors then rent out property. Some refinance the improved home with a conventional mortgage and use the loan proceeds to pay off the hard money loan.
Advantages of Hard Money Loans
As opposed to traditional loans, hard money loans are quicker to obtain: in most situations, hard/private money lenders issue loans within a week, while traditional loans could take up to 60 days to issue. This is especially advantageous for real estate investors who are trying to acquire properties with many competing bids. A quick close with a hard money loan will advance a buyer’s position and distinguishes their offer from other buyers, especially those that use slow conventional financing.
More lenient and fewer borrower qualifications: As opposed to traditional lending, hard money loans do not rely on the buyer’s credit rating in their assessment. Instead, the borrower will have to present a plan showing how they will pay off the hard money loan. Usually, hard money lenders approve loans for those who wish to improve and sell a property. Or even for those who wish to obtain long-term financing later on.
Interest and payments: Because of the higher risks, hard money loans will have higher interest rates as compared to conventional loans. Interest rates for hard money loans range between 10% to 15% depending on the lender and the perceived risk. However, different from a conventional mortgage, hard money borrowers make monthly interest-only payments. The borrower will repay back the loan when the term ends.
Minimum credit rating: For some investors, credit rating remains a hurdle. Many investors remain incapable of qualifying for a loan because they lack a good credit score. This is not the case for hard money loans. What really concerns private money lenders is whether or not a borrower has sufficient equity in the property that is being used as collateral.
What Are the Different Types of Hard Money Loans?
Hard money loans can come in three different types; these are:
Mortgage Refinancing
This is the case with buy-and-hold investment properties. Mortgage refinancing is when you or a real estate investor swaps out an old loan for a new one. The new loan will pay off the old one, and you start making payments to the new lender. Mortgage refinancing can help improve your financial situation either by lowering monthly payment and lifetime interest costs, consolidating debt, or possibly getting tax benefits.
Equity Loans
These loans have become increasingly popular after the Tax Reform Act of 1986. Consumers resorted to equity loans to protect against one of Act’s main provisions which eliminated deductions for the interest on most consumer transactions. A home equity loan or second mortgage allows homeowners to borrow against their equity in the home. Real estate investors use equity loans because they tend to have lower interest rates. Equity loans are also easier to obtain regardless of your credit score.
Bridge Loans
A bridge loan is a type of gap financing arrangement allowing investors to take loans of terms typically ranging between 2 weeks to 3 years. From its name, bridge loans help in bridging the gap between short-term cash commitments and long-term loans. One advantage of bridge loans is the fact that these loans allow you to buy a new home without a contingency to sell.
For some real estate investors, hard money loans pose a viable option. Although interest that lenders charge is relatively too high, real estate investors seek these loans for the promptness in issuing them. Moreover, those who do not qualify for a mortgage because of a bad credit score can resort to hard money loans and secure financing through it. Additionally, since conventional lenders do not give loans for distressed properties, investors seek hard money loans.
Having explained what hard money loans are, we hope that you make a sound decision when selecting the type of loan to suit your investment property. If you are thinking about fix-and-flip investment properties or buy-and-hold, then consider hard money loans.
Visit Mashvisor’s blog to know more about hard money loans and other financial instruments.