What is a “Private Money or Hard Money” Loan?
Private / Hard money loan is a loan which can be obtained through ways other than using traditional banks or mortgage lenders. These funding can come from individuals or investors who will lend money in the amount based (for the most part) on the value of the property used as a collateral. A borrower would usually require this form of alternative financing because they need the funding quickly, or because traditional lenders would not approve the loan, for various reasons. The borrower can be an experienced commercial real estate investor, or a property owner.
Hard Money Lender vs. Traditional Bank
There are two key advantages of borrowing from a hard money lender compared to borrowing from a traditional bank:1) the criteria are generally easier to meet, therefore, 2) the approval process is faster.
Usually, traditional lenders would require a good credit score and available income, because they want to be sure that you will be able to repay a loan. You will only get approval for a loan when you have a good history of loan payment and your debt to income ratio shows your ability to repay loans.
With hard money lenders, the approach is different: they are not so concerned with your credit score or ability to repay. The value of the collateral you put up to secure the loan is more important for hard money lenders, because if for some reason you are not able to pay them back, they simply take the collateral and sell it. This is why hard money lenders have a relatively low loan-to-value (LTV) ratio: between 50% to 70%, to ensure that your property can be sold quickly, thus they have a reasonable chance to get their money back.
Additionally, the criteria posed by hard money lenders are often more sensible. For example, when an owner of an apartment complex requires a loan to finance renovations of the property, a traditional bank may require it to be at 80% capacity before granting a loan, to ensure the borrower’s ability to repay. This may lead the borrower into a stalemate as they cannot get funding to complete renovations because they do not meet the minimum occupancy rate, yet the low occupancy rate might be because the property is in dire need of renovation. A hard money lender could see that the apartment complex is at 60% capacity and just needs a bit of investment to make renovations to potentially fill the complex to full capacity.
Hard money loans can generally be approved more quickly than traditional ones, as they don’t need to scrutinize your loan application, income statement, bank statements, etc. because the focus is more on the value of your collateral. Since the approval process can be quick, you are able to close deals quicker than your competition - which is important when you’re trying to secure a popular property which already has multiple offers.
Is a Hard Money Loan Right for You?
The terms for hard money loans are generally shorter, between one to five years, with higher interest rate. Therefore, hard money loans would make sense if you’re trying to borrow for a short time only. For example, when you are trying to purchase a run-down property, renovate it, and then selling it for a profit (fix and flip), or when you need to secure temporary financing until a more permanent one can be obtained (bridge loan).
If you decide to that hard money loans is right for you, as a broker or borrower you would need to find a hard money lender with a good reputation who is suitable to your need. A hard money lender should be a well-established company with a portfolio of successful loans to showcase, and specialise in the type of real estate investment you wish to to seek funding for. They should be open and upfront with you on the process and fees involved.