Hard money loans (aka, private money loans or bridge loans) are short-term loans secured by collateral.

They are called hard money loans because they are secured by a hard asset, usually real estate.

These types of loans are funded by private companies and individuals rather than traditional financial institutions such as banks or credit unions.

In this article we review the main pros and cons to hard money loans.

Pros

Less Requirements

Hard money loans can be obtained by individuals and entities whose credit or financial history is less than perfect.

In general they have less application requirements than a traditional mortgage or line of credit.

This is because they focus primarily on the value of the property used as collateral rather than the creditworthiness of the borrower.

Traditional banks operate differently.  

They focus on the value of the property, the borrower's credit history, income, employment status and a myriad of other factors.

As a result, a hard money loan can be funded in rapid fashion compared to a traditional loan.

Speed

The approval process of a hard money lender is streamlined and much faster than a bank.

This can give a real estate investor a leg up when trying to purchase a property that has several competing bids.

The faster approval process is the result of less regulation and the borrower’s high equity in the collateral asset.

Most hard money lenders will ask for a borrower’s credit history, however it’s not the number one factor in underwriting a loan.

The lender will weigh other factors such as, the loan to value ratio (LTV), the borrower’s track record and their exit strategy for the property.

The lender is also protected by the collateral. 

If the borrower defaults, the lender can foreclose on the collateral property. 

Most hard money lenders do not want to go through a lengthy foreclosure process, so they will do their due diligenceduring the underwriting phase.

However, the process is much faster and it’s not unheard of for a hard money loan to be funded in less than a week.

Flexibility

The third advantage of a hard money loan is flexibility.  

Every hard money lender is different, and many of them will negotiate terms unique to the individual borrower.

A property in disrepair that a bank wouldn’t touch with a 10 foot pole, a hard money lender will consider, especially if they see a fix and flipper with a proven track record.

Additionally, repayment schedules and terms can be negotiated and tailored to the needs of an individual borrower.  

As a result, the borrower has a better chance to repay the loan than if it were a one size fits all bank loan.

Leverage

The fourth advantage of a hard money loan is leverage.  

By using a hard money loan, a borrower is able to purchase more properties using less equity.

Absent a sharp drop in the real estate market, the use of leverage allows borrowers to generate higher returns on their projects.

Many hard money lenders will lend as much as 80% of a property's current value (LTV). 

Some hard money lenders will go so far as to lend based on the projected after repair value (ARV) of a property. 

Cons

Like anything in life, there are 2 sides to the coin and where advantages exist, there is certain to be a flip side.

Higher Interest Rates

Foremost among them is the fact the rates of interest are substantially higher than the rates offered by banks.

Interest rates range from 8% to 15%.  

Points taken by a hard money lender can be 2 to 4 percent of the total value of the loan.

The rates are primarily based on the property’s LTV.

The higher rates and points are due to the higher risk potential of default by the borrower.

Borrowers are expected to have an exit strategy, meaning they will either refinance the loan or sell the property quickly after it’s been renovated.

Hard Money Scams

Hard money loans can be more vulnerable to scammers than traditional bank loans.

Because hard money loans are subject to fewer regulations than traditional bank loans, there is more room for fraudulent practices.  

Borrowers need to be aware of deceptive practices and steer clear of lenders who employ them.

Like everything else in business, common sense should be applied to hard money transactions.  

How to Spot a Hard Money Scammer

• If the terms seem too good to be true, they probably are.
• If the interest rate is substantially below market for hard money loans or there is no requirement to put up collateral, then it is probably a scam. Run and hide!
• A request for the borrower to transfer title of the property to the lender is a sure sure sign of a scam (the title is generally held by a third party).
• A request for upfront fees to be “wired” before the loan can be funded.
• Be aware of any ambiguous instructions issued by the lender.

For more info on this topic checkout: 4 Hard Money Scams you Need to Look Out For.

More Skin in the Game

In order to reduce risk, lenders will require borrowers to have more skin in the game than traditional lending institutions.

One of the main reasons hard money lenders are able to fund loans quickly is due to the fact the borrower has substantial equity in the property.

Borrowers should expect to put down a minimum of 20% to 30% of the property’s purchase price, however requirements vary from lender to lender.

Higher loan to value ratios take more time to underwrite and are associated with higher interest rate and more points, due to the risk of the deal.

Lenders may also take a more conservative approach in appraising a property, potentially reducing the amount of funds a borrower can access.

Shorter Terms

Hard money loans are also known as bridge loans.

This is because they are often used to bridge financial situations where obtaining traditional financing is not an option, or capital is required faster than a bank can deliver.

Most hard money loans have a duration of 6 to 60 months, this is one of the reasons they also have a higher cost.

Real estate investors are expected to refinance with a financial institution or sell the property once renovations have been completed. 

The shorter term could also be considered an advantage, as traditional banks do not have many short-term mortgageproducts that can be delivered rapidly to borrowers.

The Bottom Line

Hard money loans are ideal for borrowers who need quick access to capital for a short duration of time.

A prime example would be a real estate investor wanting to pay all cash for a property in order to get a reduced price.

Hard money loans are more expensive and more susceptible to scams. 

In spite of these drawbacks, their advantages over conventional bank loans make them a popular means of financing for savvy real estate investors, especially when time is of the essence.