A hard money loan can be used to finance your business, such as if your business has a bad credit rating and you need cash to buy or renovate a property. But before obtaining a hard money loan, you need to know how it works and the underlying risk it poses.
What Are Hard Money Loans?
Typically, hard money loans are associated with real estate investors who buy properties, quickly repair them, and put them back on the market, a practice known as “flipping.” Obtaining a conventional loan relies heavily on the borrower’s creditworthiness. But hard money loans use the subject property as collateral, enabling the investor to get the money they need quickly and without the drawn-out approval process of a conventional loan. These types of loans pose a lower risk for the lender, but a higher risk for the borrower since their property serves as collateral. Hard money loans have short repayment terms, sometimes as little as four months. Many lenders prefer the term to be short (such as less than 24 months) so they can get the money back quickly.
How To Qualify for a Hard Money Loan
Hard money loans are based on the value of the subject property, which serves as collateral, not your credit score. So if a property’s market value is $500,000, and you’re able to borrow up to 70% in the form of a hard money loan, the loan would be worth $350,000. This is the loan-to-value ratio (LTV)—a percentage of the property’s value. Hard money lenders often do not offer loans for all types of properties. For example, a lender may offer hard money loans for purchases of single-family homes, office buildings, and warehouses, but will not finance a home used as the borrower’s primary residence or ground-up construction. Borrowers must also meet the lender’s down payment or equity requirements. For instance, a lender may require a 25% to 40% down payment for property purchases.
Loan-to-Value Ratio
Lenders calculate the LTV based on the loan amount and the property’s value. The higher the ratio, the more difficult it is to get a loan. A loan’s LTV is a measure of the lender’s risk. Loans with low LTVs pose a lower risk for the lender, and vice versa. The LTV calculation is simple: Loan amount / property’s appraised value = LTV Let’s say that Company ABC wants to buy a building for $100,000. They can put down $30,000 as a down payment but need to borrow the remaining $70,000. The LTV for the loan is 70%.
Interest Rates and Other Terms on Hard Money Loans
Typically, hard money loans have higher interest rates than conventional loans because hard money loans pose higher risk for the lender. For example, if the average rate for a 30-year fixed-rate mortgage is 4.98%, you may pay an interest rate of 6.95% or higher for a hard money loan. Some interest rates could be as high as 10% or 12%. Repayment terms on a hard money loan are also less favorable than on conventional loans. Hard money loans are short-term loans, some with terms as short as four months, 12 months, or just typically less than 24 months. Such short terms can create high risk for the borrower.
Hard Money Lenders
Hard money lenders are individuals or companies that fund investments. To be a hard money lender, they must be flexible and able to move quickly to take advantage of opportunities in the marketplace. They are not restricted to the rigid criteria of traditional business loans and traditional business sources. A simple internet search can yield hundreds of hard money lenders. Before taking out a hard money loan, do your research to make sure you are dealing with a reputable lender. Call them, check with others who may have used the company in the past, and ask real estate developers or agents in your area for any opinions.
