If you are thinking about flipping houses but are concerned that you won’t qualify for a loan from a bank, hard money could be the right option for you.
Most people who are first time investors in real estate are unfamiliar with hard money loans. They are a powerful tool if you are looking at buying properties. Before we talk about the benefits of hard money loans, let’s start with the basics.
Defining a Hard Money Loan
This type of loan has a “hard” asset backing it. It is a piece of property that is tangible, allowing for the quick repayment of the loan. This is different than a traditional mortgage that is backed by the home’s value and the borrower’s credit and promise of repayment.
Hard money construction loans are private. Funds are given by private lenders. Traditional mortgages are provided by financial institutions that are regulated by the government. However, a hard money lender is basically doing what banks do, loaning money.
The difference is seen when you look at the term of the loan, its purpose, and the process for approval.
Why Would Someone in Austin, Texas Use a Hard Money Loan?
This type of loan is going to be used by a real estate investor who is looking for funding in the short term to close an investment deal. When there is a good deal available, it disappears fast. Having access to cash makes an investor more likely to get the deal.
A hard money loan is usually used for two purposes.
- To purchase, fix, and flip a home with the goal of quickly getting your money back and repaying the loan.
- To close the gap between purchasing an investment property and long-term financing.
Property investors who use the buy and hold method may use a hard money loan to get a property and renovate it quickly. Once the renovation is done, they might refinance their debt using an traditional lender.
Hard money loans are a good option for a person who wants to flip houses but can’t borrow from a bank. Maybe they don’t have great credit or traditional lenders don’t feel that the deal matches their strict guidelines
The borrower needs to be cognizant of the fact that the interest rate for a hard money loan is going to be higher than traditional interest rates. These higher rates compensate lenders for increased risks.
Factors That Separate Hard Money Loans From Traditional Loans
Traditional loans stretch for 15-30 years. Hard money loans usually last six to 18 months. Interest rates for hard money loans are between four and 10 percent higher than traditional loans. Traditional loans are for homeowners looking to occupy their properties, whereas hard money loans are for short-term investments. A hard money loan uses property as collateral. A traditional loan has a borrower’s personal credit and the property they are purchasing to back it.
Important Facts About Hard Money Loans
Hard money loans cover purchasing the property and renovation expenses. Expenses covered in the loan are typically limited to those that would increase the property’s value.
Funds are disbursed using predetermined draws based on the contractor’s needs. The first draw is to cover the purchase of the property. Following draws will be based on the needs laid out in the renovation schedule
Lenders focus on the deal. Is the property being purchased at a discount? Has an accurate budget been made for renovations? What is the likelihood that the property will sell quickly and for profit?
The terms of the loan you will get vary based on the lender and where you are located. Typically, interest rates are between seven and 12 percent and loan origination fees are between one and three percent. Most loans can be approved in as little as seven days
The Pros and Cons of Hard Money Loans
One pro is the ability to close quickly. The loan is backed by the property value, so you are not personally liable for the loan. Credit worthiness is not a factor when considering approval. You won’t need the typical 20 percent down for the loan like you would with traditional investor financing. Also, a hard loan might be a great bridge to long-term financing.
The downside is that you have higher interest rates and high additional fees. You will need to be able to finish the home renovation on time. If not, financing can become expensive. If the home isn’t finished on time, the client has the deed as loan collateral. You may walk away with nothing. Since the price on the loan was an estimate by a contractor, you might not be able to complete the renovation on time if there are unexpected expenses.
Real estate investing can be expense. It’s all about the numbers. Hard money loans and other financing options can be a blessing if used properly. Take the time and determine if a hard money loan will help you close a deal that will deliver the profits needed to meet your goals.