Hard Money Loan
A type of financing that uses physical property as loan collateral
What is a Hard Money Loan?
A hard money loan is a type of financing that a borrower receives with physical property used as loan collateral. The loan – most often issued by private investors or non-bank financial companies – is typically used to provide relatively short-term financing. Hard money lenders expect to see their principal loan amount, plus interest, within one to five years.
Because of the relatively short life and greater risk associated with hard money loans, the interest rates on such loans are usually steeper than the rates for more conventional property loans.
Summary:
- Hard money loans are a source of financing backed by physical assets (usually real estate).
- Lenders use the loan-to-value (LTV) metric to determine how much capital they can safely offer in the loan.
- The loans are usually costlier than other loan types; therefore, they should only be used if a traditional loan is not an option.
Hard Money Loan Amounts
The hard money lender determines how much they can offer to a borrower by using the loan to value (LTV) ratio. The LTV metric is calculated as the total loan amount divided by the value of the property used to back the loan.
The LTV ratio is important to investors/lenders because it helps them numerically express the strength of the loan. Hard money lenders typically offer a loan amount that is 65% to 75% of the collateral asset’s value. Therefore, if the loan is a mortgage loan, the borrower is asked to put up a down payment of 25% to 35%.
Using conservative loan-to-value ratios enables hard money lenders to rest fairly well assured that if they need to foreclose the property, they should able to quickly resell it for a profit – that is, for considerably more than they loaned against it.
The Reputation of Hard Money Loans
In the past, hard money loans suffered a bad reputation, primarily due to the fact that a number of predatory lenders decided to offer high-risk, high-interest loans to clients who didn’t understand what they signed up for. The lenders’ goal was to offer loans backed by real estate, knowing that they would ultimately foreclose on the properties.
In the past several decades, the Federal Reserve used regulations and mandates to prevent predatory lending practices. Still, for many, hard money loans are looked at as less than reputable.
What Hard Money Loans Should Be Used For
Hard money loans are typically best suited for deals that involve properties and real estate. Almost all hard money loans use some type of real estate as collateral. However, they may sometimes be backed with other hard assets. The loans’ real appeal for a borrower is that they can be a source of financing when traditional loans aren’t available or when the borrower needs to secure financing quickly.
The loans can ideally be used:
- If the borrower possesses a less-than-perfect credit score (hard money lenders focus on the value of the property rather than on the borrower’s credit score)
- When financing for a project is needed immediately (hard money lenders deliver loan funds substantially faster than traditional lenders usually do)
- When an individual or group plans to purchase a property, fix it up, and flip it immediately (if the borrower expects to be able to pay back the loan in a short period of time, the higher interest rate charged by hard money lenders does not present as much of a problem)
Finding a Hard Money Lender
In order to obtain a hard money loan, borrowers must get connected with investors. It’s not usually difficult to ask locally and find individuals or companies that give out loans backed by real estate. Real estate agents are a great tool to utilize in such regard. Above all, it’s important to speak with several lenders, make sure they are credible, look at their track record of hard money loans, and how profitable the venture ended up being for the borrower.
Additional Resources
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:
