Hard money loans are a type of private financing often referred to as short-term bridge loans or asset-based lending and used to address short-term needs like the purchase of real estate and renovation costs. Hard money loans are also used as bridge financing until fixed-rate, long-term financing is available.
What Is a Hard Money Loan?
A hard money loan is a nontraditional source of financing, typically offered by an individual or small business lender. Available loan amounts vary widely based on the particular lender and the project being financed. However, this typically translates into more flexible loan amounts than those available through traditional financial institutions.
Borrower eligibility requirements are often less rigorous than for banks. This can make hard money loans a good option for business owners who need to get real estate under contract quickly, without the formalities required by traditional lenders. There are some tradeoffs, though—interest rates may be higher and there is still the risk of default and foreclosure that comes with traditional mortgages.
How Does a Hard Money Loan Work?
Unlike standard mortgages, hard money loans are offered by individuals and lending companies—not traditional banks and financial institutions. This means that real estate investors, developers, and other prospective borrowers don’t have to meet the strict borrowing requirements often associated with the mortgage process.
With a traditional mortgage, the lender evaluates the loan application based primarily on the creditworthiness of the borrower. Hard money lenders, however, base lending decisions primarily on the value of the property being financed. This results in a much less rigorous—and less time-consuming—application process that is appealing to many real estate professionals.
However, this streamlined application process often translates into more risk to the lender. To offset these risks, hard money lenders often charge higher interest rates than may be available for traditional mortgages and other forms of financing. Borrowers may also encounter additional fees, though this varies by lender.
What Are Hard Money Loans Used For?
Hard money loans are most commonly used to purchase or rehabilitate real estate. However, they can also be used as a form of bridge financing or to buy and hold properties. These are some common uses for hard money loans:
- Fix and flip properties. Hard money loans are an excellent source of funding for flipping projects, especially those expected to take less than six months. Lenders also face less risk when financing the acquisition and renovation of fixer-uppers because it’s more likely a project will be completed and resold if there is ample money for improvements.
- Investment properties. Hard money loans can be used to finance traditional investment properties, including single-family and multifamily rentals—and in some cases short-term vacation rentals, though this is less common.
- Commercial real estate. These loans are also a popular option for the purchase of commercial real estate. As with other purchases, using hard money loans in place of a conventional mortgage or business loan speeds up the lending process and enables buyers to lock down the perfect commercial property quickly, without waiting for the traditional approval process.
- Real estate development. Real estate developers who need cash to get their projects off the ground—or stay on schedule—may also benefit from hard money loans. Cost overruns are hardly rare in the development business, and this type of financing can help fill short-term funding gaps to help developers finish projects.
- Residential properties at risk of foreclosure. Property owners facing short-term cash shortages—such as those that can occur in the middle of a renovation—can use hard money loans to cover their holding costs until they sort out their shortfall.
In contrast to conventional financing, a real estate investor can use a hard money loan to purchase a property more quickly than funding is typically available through traditional banks and lenders. The borrower can then refinance with a conventional loan after 12 to 36 months.
Hard Money Loan Rates
|Interest Rate||10% to 18%|
|Origination Fee||>1% to 5% of the total loan amount|
|Underwriting Fee||$500 to $5,000|
|Appraisal Fee||$300 to $1,500+|
|Down Payment||20% to 30% for residential properties
30% to 40% for commercial properties
Conventional financing for residential properties typically requires a downpayment of 20% of the purchase price to avoid mortgage insurance. Commercial properties generally necessitate a 25% down payment. However, some lenders allow for HELOCs or mezzanine financing that can take the loan-to-value (LTV) ratio up to between 85% and 90%.
Pros and Cons of Hard Money Loans
- Loan approvals and closings are faster than with traditional loans
- Financing is more accessible to less creditworthy borrowers
- Can help fund fix and flip projects that don’t qualify for conventional financing
- There may not be underwriting fees, prepayment penalties, or other costs commonly associated with traditional lenders
- Can make it possible to get off-market properties under contract quickly, without waiting for the traditional mortgage approval and underwriting process
- Interest rates may be higher than for traditional lenders
- Maximum LTV ratios may be lower than with conventional financing
- Points are paid upfront
- There’s a risk of default and subsequent foreclosure, though this is also true of conventional financing
- Can be difficult to layer hard money loans on top of conventional financing if a property is already used as collateral for another loan
Alternatives to Hard Money Loans
Hard money loans can be an alluring financing option for many real estate investors and developers. However, this type of financing isn’t always the best fit—especially for creditworthy borrowers, those who don’t require fast funding times, and people purchasing owner-occupied real estate. If you think a more traditional loan is better suited to your needs, consider these alternatives to hard money loans:
SBA 504 Loans
Backed by the U.S. Small Business Administration (SBA), SBA 504 loans are available to small business owners who need to finance major fixed assets like the purchase of land, the purchase or construction of buildings and new facilities, and investment in long-term machinery and equipment. Funds may also be used to modernize or otherwise improve land, streets, utilities, parking lots, landscaping, and existing facilities.
These long-term, fixed-rate loans are reserved for assets that promote business growth and job creation, but eligible borrowers can access funds up to $5 million. Repayment terms are available for 10, 20, or 25 years, and interest rates hover around prime rate, or LIBOR plus 3%.
The SBA also offers other loans for small businesses that can be used for the purchase of real estate, including SBA 7(a) loans. However, SBA loans come with a 2% to 3.75% loan guarantee fee that’s charged on the portion of the loan insured by the SBA, and this can add to the overall cost of borrowing.
Home Equity Loans
A home equity loan is a type of secondary mortgage that lets homeowners borrow money against the equity they already have in their home. A borrower generally must have at least 70% to 75% equity in their home to qualify for a home equity loan. However, this requirement reduces the risk to the lender, so this form of financing often comes with lower interest rates than those available from hard money lenders.
For the same reason, home equity loans can be a riskier option for borrowers because the loan is secured by their home—not the commercial real estate, equipment, or other business assets being financed.
Government-backed FHA loans are insured by the Federal Housing Administration (FHA). Because FHA loans are guaranteed by the federal government, they pose less risk to lenders and come with lower interest rates than many traditional mortgages. This makes FHA loans more accessible to borrowers who may not otherwise qualify with private mortgage lenders, such as those with a low credit score or a history of bankruptcies.
Keep in mind, though, that FHA loans are only available for owner-occupied real estate and they can take between 30 and 60 days from application to closing. For that reason, a hard money loan may still be the best bet for real estate investors purchasing rental properties—especially those who need money quickly. But, if you’re shopping for your primary residence and have poor credit or may struggle with a downpayment, an FHA loan may be a good option.
VA Home Loans
VA home loans are backed by the Department of Veterans Affairs (VA) and are reserved for eligible veterans, service members, and their spouses. Funds can be used to purchase an owner-occupied residential property, and no downpayment is required. As with other government-backed loans, VA loans have less strict lending requirements, a less robust approval process, and lower costs.
This means that VA loans may be accessible to low credit borrowers, and may offer higher loan amounts than other traditional lending sources. Still, the application process is lengthier than for most hard money loans, and the uses are much more limited—especially for real estate investors. But, if you’re a military veteran or current U.S. service member, a VA loan may be a good alternative to avoid the high-interest rates typical of private loans.
Hard money loans may be a good option if you’re trying to finance the purchase or renovation of an investment property, need funds to complete a real estate development project, or otherwise need access to fast cash for a real estate deal. That said, it’s important to consider the realities of a hard money loan before committing to this less traditional form of financing. It’s also helpful to understand possible alternatives so you can choose the best type of loan for your business.
Are you looking for a loan to finance commercial property or your next real estate investment? One of our reps would be happy to guide you through the process. Tell us a little more about your project, and someone from LoanBase will contact you to explain your options.