Pros and Cons When Borrowing Hard Money: What You Need to Know
When you're in the market for a loan, you might have heard the term “Hard Money.” Hard money loans are a particular type of loan backed by assets rather than credit.
Hard money loans can be beneficial in several situations, but it's essential to understand the pros and cons before borrowing. This analysis will discuss the advantages and disadvantages of borrowing hard money, helping you make a well-informed decision about whether this type of loan is right for you.
What's the definition of “Hard Money Loan” in general terms?
In general terms, a hard money loan is a type of asset-based loan financing in which a borrower receives funds backed by real estate. These loans are usually issued at much higher interest rates than traditional loans and for much shorter terms, making them a high-risk but potentially lucrative investment.
The History Behind Hard Money
The term “Hard Money” historically referred to the physical properties of money, which, unlike paper currency, is made of hard materials like gold or silver. The old English phrase “cold, hard cash” refers to this.
People distinguished between “hard” metal coins and “soft” paper money because metallic coins are solid, physical tokens with intrinsic economic value independent of their monetary status. On the other hand, paper fiat currency only represents a promise to pay the bearer in physical money upon redemption.
Nowadays, “Hard Money” loans are loans that are not based on the borrower's credit score but rather on the asset's value being used as collateral, making the term “Hard Money” seem outdated. However, the phrase is still helpful, especially if you're a property developer or landlord looking to extend your portfolio.
How Do Hard Money Loans Work?
A hard money loan is a short-term loan secured by real estate. Private investors or companies typically issue hard money loans. Hard money lenders typically focus on the property's value as collateral, not on the borrower's creditworthiness.
Investors use the loans to purchase, refurbish, or refinance properties, and they are usually for a shorter term than traditional loans, such as 12 months. Interest rates can be as high as 15%, but they are often 12% to 25% depending on the lender and the economic climate.
Quick Approval
There are advantages to securing a hard money loan. One advantage is that hard money loans can be approved quickly, often as little as 24 hours. Quick approval can be helpful if you need to secure funding fast for an emergency or opportunity.
Another advantage is that hard money loans can be used for various purposes that are beyond the remit of conventional lenders, including business expansion, renovation projects, or even refinancing other loans.
However, there are also some disadvantages to taking out a hard money loan. One of the most significant disadvantages is that hard money loans have high-interest rates. High interest means that you will likely end up paying more in interest over the life of the loan than you would with a traditional loan.
Additionally, hard money loans are often for shorter terms than traditional loans, so you will need to repay the loan much sooner. Early paybacks can be difficult if you cannot generate enough revenue quickly to make the payments.
Before taking out a hard money loan, it's vital to understand both the advantages and disadvantages or the pros and cons. Weighing these factors will help you decide if borrowing hard money is suitable for your situation.
Advantages:
-Hard Money Loans can be approved quickly, often in as little as 24 hours.
-Can be used for a variety of purposes, including business expansion or refinancing other loans.
-In contrast to traditional loans, you do not need to pre-qualify for specific loan amounts calculations are based on value rather than credit score.
Disadvantages:
-Hard Money Loans have high-interest rates, which could end up costing more in the long run.
-Loans are often for shorter terms, which means repayment is much sooner than traditional loans, which could be problematic.
-Borrowers may be required to provide additional collateral to secure the loan.
Take away:
Hard money loans are not based on the borrower's credit score but rather on the value of the asset being used as collateral; you can access money quickly.
Hard money loans have advantages, and flexibility is one of them. Flexibility means that the amount you can borrow could be more than a traditional loan or mortgage.
Other advantages include quick approval, and loans can be used for various purposes, while, as we have said before, disadvantages include high-interest rates and short terms.
You may need to provide additional collateral or guarantees to secure the loan in some cases. Still, the general rule is that arrangements are evaluated on an individual basis or case-by-case scenario.
Professionals in your specific field usually handle hard money loans. They understand your requirements. Usually, you deal with an individual or a private company rather than a bank with a strict policy or “computer says no” attitude.
Finally – before taking out a hard money loan, it's important to understand both the advantages and disadvantages or the pros and cons. Always speak to a professional financial advisor who is part of a professional body such as the American Association of Private Lenders.
Weighing these factors will help you decide if borrowing hard money is right for your situation.
1 comment
Thanks. Great job describing what a hard money loan is and some of the advantages and disadvantages.
It is important to compare hard money lenders. Using a reputable direct local hard money lender can have many advantages, including saving money and time and avoiding scams or last-minute term changes.
A local direct hard money lender means that:
• the money is coming directly from a single source controlled by the individual(s) underwriting the loan, not from a fund, multiple people, set limited partners, a publicly owned company, and other situations where more than one person is providing the money, and not a loan arranged through a mortgage broker; and
• The hard money loan is underwritten by an individual residing relatively close to the collateral property.
There are hard money funds that are local, but their obligations and motivations are often different. A local direct hard money lender can be flexible and practical. For example, funds may have contractual obligations to obtain an appraisal for every property. A direct hard money lender may not require appraisals.
There are brokers who work with multiple hard money lenders (including direct lenders and fund lenders with multiple investors). Such brokers might choose the lenders who pay them the most rather than the lender with the best terms for the borrower. Also, brokers may not have local knowledge and could have much less incentive to ensure the borrowers or lenders don’t lose money in the end.
Save Money…
Skip the appraisal – Local direct hard money lenders often loan without appraisals. Many local hard money lenders do not require appraisals for one-to-four-unit residential properties. This can save you money and time. In contrast, hard money funds cannot skip the appraisal; they are contractually obligated to obtain one. That can delay closings and cost the borrowers hundreds of dollars.
Avoid upfront fees – Many local hard money lenders do not charge upfront fees (i.e., fees paid to the lender/broker before the loan origination). Often, these upfront fees are non-refundable. Some lenders will charge small application fees (less than $100) that cover costs like credit and background checks.
Avoiding losses on the back end – A mortgage broker or fund manager, will often make money just by getting the loan originated. That person may not take on any risk if the property is worth less than expected. That risk may fall solely on the borrowers, the fund investors, or the party providing the loan funds. A person may be much more concerned with risk of losses for the borrowers and lender, if that person is directly providing the money. Sometimes, local knowledge can help you better estimate the current and future value of the property. Appraisers will sometimes not base their figures on comparable properties (which can occur for legitimate reasons, like no recent nearby sales being available). Local knowledge can involve knowing that a location is downwind of a brewery or factory, differences in schools, local government policy changes, or other local dynamics that can impact value.
There is no guarantee that a local hard money lender will have important local knowledge, but there’s a better chance they will.
Avoid Scams…
Advanced Fee Scams – Beware of lenders requiring large upfront fees before the loan origination. Also, beware of “release fees” or any charges to have the loan funds released. These types of schemes are commonly known as advanced fee scams. Borrowers should not need to pay advanced fees to a “lender.” Fees paid to third parties (e.g., inspectors, surveyors, structural engineers, etc.) may be legitimate; however, it’s important to first verify that those vendors are legitimate businesses. You can avoid some fake lender scams by verifying and directly paying vendors prior to the loan origination.
Other scams – Avoid additional scams by (1) meeting with a loan decision-maker in person; (2) verifying that the person and company are real; and (3) verifying that your contact is the actual person they claim to be. Because scammers are often remote and don’t want to be identified, they may be unwilling to meet in person. Verify the company by checking the company’s state registration. The Secretary of State usually maintains a database of company registrations, including addresses. Verify in multiple ways that the person you are taking to with is who you think they are: (1) call the phone number on the company website to reach that person; (2) the website might be a front, so verify by going to the Better Business Bureau (BBB.org) and checking for the rating and history for the metro area the property is in, as well as calling the phone number listed with the BBB to reach your contact; and (3) check public records for mortgages/deeds of trust and verify details such as the company’s address.
Avoid surprise fees and last-minute term changes…
Sometimes, a hard money lender is really just a broker who arranges loans from others. Such a broker can promise low rates and fees to get borrowers. However terms may change shortly before closing (when the borrower has little choice). The broker might claim their original fund source backed out or that some other unexpected situation arose. Local direct hard money lenders are less likely to use deceptive practices like this. Typically, local direct hard money lenders are concerned about their reputation in the community and highly value repeat business. Whether lenders are local or not local, look for honest and ethical people. Generally, involving yourself with people who highly value ethical behavior and care about others is a good practice. If the rates and fees are not clear on the website, ask for a written term sheet. The term sheet should include rates, fees, and conditions to close among other details.
Note: If an application provides materially incorrect information, it is likely and reasonable the terms will change. An example where terms might change or loan offer cancelled: The borrower states the property is in good shape with no issues, there are roof leaks, structural issues, or other issues that could affect the current or future value the property.
The content and information above (the “Content”) is not meant to be comprehensive nor constitute professional advice. The Content is for general informational purposes only. The Content may not be the most up-to-date information. Circumstances and facts of your situation may require additional information and you should consult with experts and experienced professionals before acting. You should not rely on the Content. I am a direct local hard money lender.