What are Hard Money Loans and How Do They Work?
Hard money loans provide cold, hard cash quickly – typically in just a few days. These loans are secured by a physical asset (like real estate) that the lender can take ownership of if you default. However, hard money loans do have a reputation of being predatory — in exchange for being fast, they typically have high interest rates. They’re most often used in real estate as short-term, bridge loans.
How a hard money loan works
Individuals, investment companies and other private, nonbanking businesses provide hard money loans. Real estate is most commonly used as collateral for a hard money loan, but other hard assets such as vehicles, equipment, machinery and precious metals could also secure the loan.
In order to offer a fast closing time, hard money lenders typically don’t look into your credit history. They mainly base the loan on the value of the collateral. You cannot borrow 100% of the asset’s value either, but rather only 65% to 75%. The lender wants to leave some room for profit in case you default.
Hard money loans themselves have high APRs and loan terms of one to five years.
Why use a hard money loan
This type of loan can be useful when you’re between a rock and a hard place. If you have poor credit or need a large sum of money quickly, a hard money loan could help. Be aware, though , that it’s a more expensive way to get the cash you need.
What is BRRRR?
Besides being a noise you make when you’re cold, BRRRR stands for “buy, renovate, rent, refinance and repeat” — it’s an acronym and method used by house flippers. If you don’t want to wait the six weeks or so that it takes to close on a mortgage refinance, you could use a hard money loan to help you complete the BRRRR process instead.
Hard money lenders
Credit unions and banks don’t offer hard money loans. Instead look to:
- Real estate investment lenders
- Equity companies
- Asset lenders
You may qualify for different lenders depending on whether you want to take out a business hard money loan versus an individual one, and whether the asset is owner-occupied.
Pros and cons of hard money loans
Hard money loan pros
No minimum credit requirement: Hard money lenders tend to rely solely on the value of the collateral securing the loan and don’t take the borrower’s credit score into account.
Quick closing time: Rather than the loan closing process taking weeks and weeks, hard money loans generally close in a few days.
Short terms: If you expect to repay the loan quickly, even a high interest rate may not add up to a large bill.
Hard money loan cons
High interest rates: Because the lender isn’t taking your credit score into account, the loan is considered riskier and earns a higher interest rate than other loan types.
Lower loan-to-value (LTV): In a hard money loan, you may be able to borrow up to only 75% of the asset’s value. Meanwhile, you could borrow up to 85% in a home equity line of credit (HELOC).
Risk of losing the collateral: If you default on the loan, you’ll lose the asset you put forth to secure the loan.
Alternatives to hard money loans
There are several alternatives to hard money loans. If you have a hard money loan, you could use one of these to replace it as well: