3 things investors must know about hard money
Hard-money loan characteristics
- Private-money loans, not offered through banks
- Helpful for those who can't get traditional bank financing
- Backed by hard assets, such as the property that's being financed or other property
- Lenders less concerned with borrower's credit rating
- Expensive financing, with higher interest rates and fees
- Short-term loans, sometimes refinanced with conventional bank financing
They're pricey, potentially risky and far from a long-term solution to anyone's financing needs, but hard-money loans are an important part of the commercial mortgage landscape. At their best, they're a good alternative for those unable to land a commercial mortgage from a bank, or who can't afford to wait for a bank lending decision.
Backed by hard assets
Hard-money lenders fund mortgages that are backed by hard assets. They're more concerned about the value of the property you're financing than they are about your credit rating, or profit and loss statements. The term “hard-money loans” is often interchanged with private loans, as well as no-documentation loans, bridge loans, short-term loans, transitional loans and asset-based loans. Whatever the name, the loans are thought of as nontraditional funding — the kind that isn't offered by traditional banks.
Easy to obtain
While hard-money loans are easier to get than bank loans, borrowers pay a premium in terms of higher interest rates than those charged for traditional loans. The added expense can be considerable, and most borrowers don't want to pay that price for long. Most hard-money loans are designed to act as temporary, short-term financing that borrowers will eventually replace with cheaper, conventional financing.
For the most part, borrowers in the market for hard-money loans are there because they can't get traditional bank financing. Sometimes they're turned down because of a rocky or thin credit history, or sometimes because of bank lending standards.
Those commercial mortgage borrowers find that private lenders are more receptive, as long as the would-be borrowers have equity in the property — which the hard-money lender could seize if the mortgage goes unpaid. The equity could be in the property that's being financed — equity created in the form of a large down payment on the property — or in another property that the private lender accepts as collateral for the loan.
Hard-money lenders often make lending decisions in a few days — about as long as it takes to determine whether the borrower's collateral justifies making the loan — as opposed to a month or more, for banks. Thus, hard-money loans are particularly attractive to those who need to act fast on a purchase, or who spot an outstanding investment opportunity and are confident they can sell the property quickly at a profit.
Among other uses for hard-money loans is paying off tax liens or debt judgments, buying out partners or financing transactions involving multiple properties. Whatever the purpose, the key is having the equity necessary to satisfy the lender, and some expectation that you'll eventually be able to find less expensive financing.
Hard-money lenders will finance most types of commercial properties, and sometimes raw land slated for development. But more often than not, individual lenders have specialized interests, which you'll want to inquire about before you apply for a loan.
Look closely at the terms of hard-money loans including the down payment, interest, loan-term and prepayment-penalty provisions of the contract before you sign it.
Unless you have other property you're willing to commit as collateral, expect to make a big down payment on a private loan. You'll need to come up with at least 25 percent of a property's value to satisfy most hard-money lenders — and often 30 percent to 40 percent of the value. They'll also want to be in the senior position in relation to any other lenders, so they know there will be equity to collect should the loan go into foreclosure.
Hard-money lenders are taking a bigger risk than more conservative bank lenders, and their interest rates are designed to compensate for it. Rates vary, but can easily be double the cost of the best residential mortgage — starting at 8 percent, for instance, and into the high teens. As with traditional financing, expect to pay closing costs and other lending fees, usually at rates higher than those charged by traditional lenders.
Hard money loans are short term — sometimes as short as three months, sometimes as long as three years — and can include substantial prepayment penalties. Oftentimes borrowers will refinance the loan at the end of the term into a conventional mortgage. Hard-money loans are frequently interest-only, meaning borrowers need to refinance the entire principal amount at the end of the loan period.