Whether you’re just starting out as a real estate investor or you’ve been in the game for a long time, the odds are that you need to secure financing to make the investments you want.
Although there are a lot of different financing options, including conventional loans, you should make sure to look at hard money loans. Hard money loans come with a number of advantages over other types of loans, especially when used for real estate investing. The question is, how exactly do they work?
What Is A Hard Money Loan?
A hard money loan is simply a loan that is secured by real estate. This means that if you use a hard money loan to buy property, that property will be used as collateral for your loan.
Hard money loans are issued by private lenders and are therefore an alternative to traditional bank financing. They are typically used for short-term financing by real estate investors because they are easier to qualify for than other types of loans.
Why Borrowers Seek Out Hard Money Loans
There are a number of reasons why borrowers seek out hard money loans. For example, they are useful when the borrower doesn’t have the time to go through the lengthy process of getting a traditional loan. Hard money loans are often approved faster than traditional loans.
In other cases, the borrower might not have the necessary credit score or history to qualify for a traditional loan. Hard money loans are easier to qualify for because they are secured by real estate.
Although there are a few general reasons why borrowers might want a hard money loan, the following are four reasons why real estate investors might specifically prefer hard money loans:
1. For Fix-and-Flip Homes
One of the most popular uses for hard money loans is to finance the purchase of a fixer-upper home that will be flipped for a profit. Investors often need to secure money for both the property and the repairs, which can be done with a hard money loan.
Additionally, they’ll want to secure the loan quickly before the property is sold to someone else. Hard money loans are ideal because they can be funded quickly and they usually have shorter terms than other types of loans. Since most fix-and-flip investors try to flip their investment properties as quickly as possible, a short-term loan suits them well.
2. Investing In Rental Properties
Even though rental properties are long-term investments, hard money loans are still useful in these situations. This is especially true if you want to invest in a rental property but either don’t have the best credit or you don’t have enough money to make a down payment.
Hard money loans are also beneficial for investors with multiple rental properties. This is because they’ll be able to add to their portfolio with the added financing, but will have no trouble paying back the loan since they can use the rental income from their new rental property as well as their existing ones.
3. Commercial Real Estate Purchases
Just like with residential real estate, hard money loans can also be used to finance commercial real estate, including office buildings or retail spaces. The loan can be used to cover the entire purchase price or just a portion of it.
Because of this, investors often seek out hard money loans for commercial real estate. Hard money loans can be funded quickly and are easier to qualify for than other types of loans, making them ideal for commercial investments. Additionally, the loan terms are often more flexible, which is beneficial for investors who want to keep their options open.
4. Lack Of Cash
Many real estate investors seek to secure hard money loans because they do not have the cash to cover the down payment, renovations, or closing costs of a real estate investment deal.
Using hard money loans for these reasons isn’t uncommon, even among successful investors who have multiple properties already.
Real estate isn’t very liquid, which means that even though these investors have assets with significant value and a steady stream of income, they may not have cash reserves large enough to cover the out-of-pocket expenses of any additional investments that they’ve lined up.
How Hard Money Loans With No Money Down Work
If you want to take out a hard money loan with no money down, then you’ll need to find a lender who is willing to offer you a loan that doesn’t require a down payment. This can be difficult to do because most hard money lenders require some form of collateral, such as real estate.
One way to get around this is by using cross-collateralization. This means that you’ll use another piece of real estate as collateral for the loan. For example, let’s say you own a rental property that is worth $200,000 and you want to take out a loan to buy a fixer-upper home that is being sold for $100,000.
You could use your original rental property as collateral for the loan. This would give the lender $200,000 in collateral and they would be more likely to give you a loan with no money down. Real estate investors with numerous properties in their portfolios will often take advantage of hard money loans for this reason.
Additionally, while most other types of loans require good credit, hard money loans are typically based on the value of the property being used as collateral, not the borrower’s credit score. This makes them easier to qualify for if you have bad credit.
The Advantages Of Hard Money Loans
Let’s outline a few reasons why you may want to consider a hard money loan as a real estate investor:
Quick Approval Process
The biggest advantage of hard money loans is the quick approval process. If you need to secure financing quickly, then a hard money loan may be the best option. Conventional loans can take 30 to 45 days to process.
Hard money loans can take as little as a few days to process. If you’re presented with an opportunity that requires immediate action, waiting around for over a month may not be an option. A hard money loan can help you capitalize on real estate opportunities that are time sensitive.
Approval Based On Collateral, Not Credit History
One of the reasons hard money loans are approved so quickly is because hard money lenders don’t base their decision on a borrower’s credit history, but rather on the asset being used as collateral. As long as you have collateral for the loan, then it’s likely you will be approved.
Another advantage of hard money loans is that they offer more flexibility than traditional loans. For example, you can often negotiate the terms of the loan, such as the interest rate, repayment schedule, and more, because they are being issued by private lenders.
Moreover, if you establish a relationship with a hard money lender, there’s a good chance that they will offer you more flexibility in the future to maintain that relationship.
The Drawbacks Of Hard Money Loans
Although there are plenty of advantages to using a hard money loan – especially as a real estate investor – it’s essential that you understand the potential drawbacks as well. These include:
Higher Interest Rates
One of the biggest drawbacks of hard money loans is that they tend to come with higher interest rates than traditional loans. This is because hard money loans are considered to be higher risk, which means that lenders need to charge a higher rate to offset that risk.
Additionally, lenders often have a preferred loan-to-value (LTV) ratio. This means that they may only be willing to lend you a certain amount of money based on the value of the property being used as collateral.
Lenders May Require Larger Down Payments
Another potential drawback of hard money loans is that some lenders may require a large down payment. For instance, if you have a lower credit score and don’t have a pre-existing relationship with the lender, they may require a larger down payment (compared to conventional loans) to help offset that risk.
Fortunately, if you have other assets, then you can bypass the down payment by using cross-collateralization. Additionally, once a hard money lender views you as less of a risk, they may even offer 100% financing.
Shorter Terms Means Less Time To Repay The Loan
Traditional loans often come with 15 to 30-year payment plans. However, hard money loans typically have shorter terms of 12 months or less. This means that you’ll need to come up with the money to repay the loan in a shorter period of time.
It’s A Riskier Financing Option
Despite being easier to secure, hard money loans are still a riskier financing option when compared to traditional loans. The primary reason for this is because of the short repayment terms and high interest rates.
Additionally, if you default on the loan, the lender may be able to take possession of the property being used as collateral. This means that if you default on your loan, the lender can foreclose on your property. As such, this is something that you need to be aware of when considering taking out a hard money loan.
Proven Track Record In Real Estate
Lastly, most lenders will only work with borrowers who have a proven track record in real estate. This is because lenders want to make sure that you know what you’re doing. If you’ve never invested in a real estate investment before, lenders will consider the financing of your investment a greater risk.
As such, first-time investors may need to secure more traditional financing the first time around.
What It Takes To Get 100% Financing On A Hard Money Loan
Even though hard money loans are easier to qualify for if you have the collateral necessary, that doesn’t necessarily mean you can get 100% financing. If you need 100% financing, you’ll need to do the following:
Be Sure The Deal Is Under 70% ARV
The after repair value (ARV) is the estimated market value of a property once repairs and renovations are completed. Most hard money lenders will only lend up to 70% of the ARV, so it’s essential that you find a deal that is well below that number if you want to secure 100% financing.
Maintain A Solid Credit Score
Even though one of the benefits of hard money loans is that you don’t need the best credit score to qualify, it’s still important to maintain a solid credit score if you want to qualify for 100% financing. A good credit score will show lenders that you’re a low-risk borrower, which means that they will be more likely to lend you the money you need.
House Flipping Experience
As we mentioned earlier, most hard money lenders want to work with borrowers who have a proven track record in real estate. If you can show them that you’ve successfully flipped houses in the past, they’ll be more likely to lend you the money you need. They’ll be comforted by your success as an investor and you’ll be considered much less of a risk.
Be Flexible With The Loan Coverage
When a hard money lender is willing to provide 100% financing, it’s important to understand that this may not cover all of your costs. To many lenders, 100% financing means that they will cover the price of the property in full.
However, there may be other costs associated with the purchase that they won’t cover, for example, certain expenses such as repairs. Whether or not a lender is willing to cover additional expenses outside the actual purchase cost will vary from one hard money lender to another.
Consider The Maximum Loan Amount
When you’re trying to secure 100% financing, it’s also important to consider the maximum loan amount. If you need more than the lender’s maximum and you’re looking for 100% financing, you’re not going to get it from them. To get 100% financing, you’ll need to borrow less than the lender’s maximum loan amount.
How To Secure Down Payment If Your Lender Requires One
Depending on the lender and on your background (i.e., your credit score and real estate investing history), 100% financing may not be an option. In such an event, you’ll have to find another way to come up with the down payment. The following are a few ways that you can secure the down payment you need:
Business Credit Cards
If you have a business credit card, you can use it to make the down payment for your hard money loan. This is a good option if you have a good credit score and you’re able to pay off the balance quickly. Just be sure that you read the fine print on your credit card agreement so that you’re not surprised by any hidden fees.
A Personal Loan
If you have a good credit score, you may be able to take out a personal loan from your bank or credit union. The interest rate on a personal loan is typically lower than the interest rate on a credit card, so this is a good option if you’re looking to save money on interest. Just be sure that you can afford the monthly payments on the loan.
Family And Friends
If you have family or friends who are willing to help you out, you can ask them for a loan. This is a good option if you’re unable to get a loan from a bank or credit union. Just be sure that you discuss the loan terms and put your agreement in writing. The last thing you want is to hurt your relationships because of a misunderstanding over money.
A Home Equity Line Of Credit
If you have equity in your home, you may be able to get a home equity line of credit (HELOC). A HELOC is a line of credit that is secured by your home equity. The interest rate on a HELOC is typically lower than the interest rate on a credit card or personal loan.
Additionally, because it’s a line of credit, you can make multiple withdrawals over time adding up to the limit – and you only pay interest on the funds you’ve withdrawn.
A Personal Line of Credit
If you have a good credit score, you may be able to get a personal line of credit (LOC) through a bank. It is similar to a HELOC except that a LOC is a line of credit that is not secured by any collateral. The interest rate on a LOC is typically higher than the interest rate on a HELOC or personal loan.
If you have a 401(k) account, you may be able to borrow from it. Doing so will allow you to avoid paying taxes on the money you borrow as long as you pay it back within the scheduled time frame. However, you will have to pay interest on the loan, and if you can’t repay the loan the money you borrowed will be considered a withdrawal from your retirement account.
A Business Loan
If you have a business, you may be able to get a loan from a bank or credit union. The interest rate on a business loan is typically lower than the interest rate on a personal loan. However, the application process can take a while, and you may need to use your business assets as collateral.
Consider All Your Financing Options Before Taking The Risk
When it comes to borrowing money, there’s always some kind of risk involved. Hard money loans are no different. Although they can be hugely beneficial (especially for real estate investors), you should always review the pros and cons.
Take a look at all of your financing options before you decide if a hard money loan is the right thing for you.