Are Hard Money Loans A Good Idea? When Is It Right For You?
Have you ever used a hammer on a screw? It does not work so well, trust me. Picking the right tool is vital to completing your goal. Hard money is an effective tool for real estate investors. However, you should not use it for every job. The key to success is understanding this tool and when and how to use it effectively.
What Is Hard Money?
There is no formal definition of hard money. The last I looked, it was not in the dictionary. Hard money can mean many different things to different people. I believe hard money has a bad reputation because of the high fees and rates. But what many fail to understand is the power and the flexibility this leverage provides.
In the world of real estate investing, hard money refers to loans provided by private individuals or companies with private capital behind them. The fact that it is private capital is important because it gives the lender a ton of flexibility in funding loans. They can do deals that other lenders only dream of. Good hard money lenders look for ways to say yes instead of kicking loans out that don’t fit into a specific box.
Who Is It For?
Most hard money loans are specifically designed with the real estate investor in mind. If you buy and sell or buy and rent houses, hard money could be the perfect tool for you.
When Is the Right Time To Use Hard Money?
As mentioned, you do not want to use hard money for every deal you do. There are specific circumstances that make hard money a fantastic option for investors.
When A Short-term Need For Money Arises
Hard money typically has short payback periods. You will likely see loan terms from six months to one year, and the rates are high. High rates mean you want to pay it back as quickly as possible. Investors with short-term needs (such as for a fix-and-flip) are perfect candidates for hard money loans.
When Purchasing A Property That Needs Repairs
Buying real estate in need of repair is the perfect time to use hard money. Hard money lenders often base their loans on an after repaired value (ARV). That is huge because it allows you to borrow much more of the purchase and repairs than you would get with alternative lenders. We, and many other hard money lenders, will consider 100% financing as long as our loan is conservative compared to the completed value. It is also important to understand that many lenders will not even loan on a property that needs work. Conventional lenders, for example, require the property to be habitable to qualify for financing. In those cases, you can use hard money to buy the property and make the repairs.
When Needing To Compete Against Other Offers
In a competitive market, like we are in right now, you will likely be competing with other offers. Even on distressed properties, many investors are swarming these properties looking for a deal. Being able to close fast with certainty can give you the advantage you need. When you need to close quickly, hard money is an excellent resource.
Hard Money Advantages
There are many advantages to using hard money.
We have clients that send us a contract and a scope of work, and we schedule closing. We have already done deals with them, so we have the documents we need, resulting in an extremely smooth process. They can focus on what they are good at and allow us to focus on the funding. Hard money lenders can be very efficient as they typically underwrite and fund their own loans, so there is minimal red tape to get through.
Because hard money lenders make their own lending decisions, they can be extremely flexible. Have bad credit or hard to document income? No problem. A reputable hard money lender wants to understand your plan and believe you can execute it. If you can show a concrete way to pay the loan back, the lender will likely find a way to get the deal done.
The project is the most critical piece to the lending decision with hard money lenders. If things do not go as expected and you default, what does the lender have to protect themselves?. If the collateral is good, the loan is easier to get done. Good collateral makes obstacles like credit and income easier to work through.
Hard Money Drawbacks
As good as it is, hard money does have some drawbacks.
Rates are typically much higher with hard money, and they will most likely want monthly payments. Monthly payments can create some real financial pressure. Before you borrow from a hard money lender, be sure you understand the rate and how that is used to calculate payments. Ensure you have money set aside and can carry the loan for as long as you will have the project. As long as you do that, you will be fine. Remember, these are only numbers. If your deal works and you budgeted for the cost of the money, do the deal. If the high price of money makes the deal too thin, look for a better deal.
With the high-interest rates, you will likely want to pay these loans back as quickly as possible anyway, but keep in mind that they all have short fuses. It is wise to understand what happens if you pass your maturity, so be sure to ask those questions.
I have heard of hard money lenders loaning on a property, hoping their borrower defaults. They are looking to take the house. Although I am sure that is true, I have never met a hard money lender that genuinely wants to foreclose on someone. Most hard money lenders will work with you if you get into trouble, but you do need to understand the house is the collateral, and if you mess up, you could lose it.
Is It A Good Idea To Borrow Hard Money?
Whether it is a good idea or not to borrow hard money comes down to each individual’s circumstances, the deal they are funding, and their goals. If you have a ton of money and plan to do a single deal at a time, I would say you should not borrow hard money. You can use cash and make more money with each deal. If you have limited funds and want to do a deal or multiple deals, hard money might be perfect for you.
Because there are multiple ways to fund your deals and every situation is different, it is smart to have a suitable hard money lender to discuss funding deals with. We love talking real estate and would be happy to discuss your deals and the options you have, even if hard money is not the best fit for your specific deal.