The term "hard money lender" may conjure up visions of crooked-nosed guys who'll cut off your pinkie finger if you flake on making prompt payments. But you can rest assured -- these professionals aren't thugs. In fact, these lenders fill a legitimate niche in the housing market for quick home loans.
So, what exactly is a hard money lender?
First, it's important to understand what a hard money loan is: It's simply a short-term loan secured by real estate.
Back to the question of what is a hard money lender: "It's synonymous with a private investor," says Don Hensel, president of North Coast Financial, which specializes in hard money loans. "A lender could be an individual, a group of investors, or a licensed mortgage broker who uses his own funds. This differs from a bank that uses money from its depositors."
Benefits of a hard money loan
Why would any home buyer opt for a hard money loan instead of getting their mortgage the traditional way from a bank? Because hard money loans are generally less of a hassle. The flip side? You can borrow the money for only a short period of time -- and at a much higher interest rate.
These short-term, high-interest-rate loans are especially popular for the following people:
Flippers: If a house in disrepair comes on the market and it looks like it could be fixed and flipped in several months, most people prefer not to go through the hassle of taking out a 15-year loan on the property.
Builders: Many contractors use hard money loans to buy a lot, build on it, then sell the new structure and pay off the loan quickly.
Investors: On occasion, a real estate investor will come across a killer deal on a property that needs to be snapped up pronto. If the investor doesn't have the money on hand, a loan can be fast-tracked by a hard loan lender, who is, in effect, a real estate investor as well.
People with credit issues: People who have cash on hand for a down payment but have been rejected by a bank for a conventional loan -- or have had a foreclosure, default, or other red flag on their recent credit report, but have some cash on hand, can use hard money loans to buy a property that would be unavailable to them otherwise.
So let's say you lost your job several years ago and your house went into foreclosure. Since then, you've found a great position and are happily employed. You've also found a killer deal on the perfect house, but there's a problem: Few banks will grant you a mortgage with a foreclosure on your record.
Chances are you can find a hard money lender that will give you the opportunity to buy that home before it slips away. You can then refinance with a traditional mortgage once time has passed and your credit score improves.
"The higher interest rates may seem scary at first, but the benefits of getting a loan funded quickly and being able to obtain financing when all the banks have said 'No' will far outweigh the extra cost," says Hensel. The closest thing banks have to a hard money loan is a bridge loan, but qualification for one may be more difficult.
How to get a hard money loan
Hard money loan terms are usually much shorter; from six months to one year is most common, but sometimes they can go up to five years. And, as you would expect, interest rates are considerably higher, usually ranging from 12% to 21%. Most hard money lenders also charge points upfront, where 1 point equals 1% of the loan. From three to six points is typical for a hard money loan.
So if you borrow $100,000 from a hard money lender, you would pay $1,000 per point charged, which would likely be an extra $3,000 to $6,000 upfront, in addition to the interest you'll be paying until the end of the loan.
Down payment requirements for hard money loans are also different. You can expect to receive about 60% to 75% of the property value you intend to purchase. If you're looking at a $200,000 property, for example, the most you'll probably be allowed to borrow would be $150,000, meaning you'd have to pay $50,000 upfront.
On the other hand, because you're not doing all the paperwork and extensive qualifying procedures required by big banks, you can usually get a hard money loan much faster. In many cases, it could take as little as one week.
Risks of a hard money loan
But you should use caution if you decide to go the hard money route. Make sure you take the time to look into the reputation of the lender, and have an experienced real estate attorney review the paperwork. While there are many legitimate hard money lenders offering loans, there are also predatory ones that try to take advantage of borrowers.
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