Pros And Cons Of Hard Money Loans And When Should You Take One?

Non banking financing options are becoming increasingly popular among real estate investors and developers alike. Hard money loans are lucrative alternatives to conventional mortgages for borrowers who need fast access to capital at flexible terms. 

Hard money loans are essentially short term lending instruments that real estate investors use to finance their investment projects. They can be used to purchase, construct or renovate an existing property. 

Since hard money loans are offered by private lenders as opposed to traditional banks, they inherently have greater flexibility in terms of risk assessment and setting up of loan terms.

If you are in the process of seeking out financing for your next real estate project, understanding the nuances of a hard money loan and evaluating the pros and cons of taking one can make it easier for you to make a decision. 

Here are the benefits and drawbacks of hard money loans. 

Pros of Hard Money Loans

1. Short loan timelines

Unlike traditional bank loans which can take months to process, hard money loans get processed much faster, sometimes in a matter of days. 

Traditional loan process goes through a number of hoops and involves a number of stakeholders like lawyers, underwriters, appraisers before the loan gets finalized. Hard money loans on the other hand are collateral based loans which means the lenders don’t have to go through the application with a fine toothed comb as in the case of a traditional loan. 

Additionally, private hard money lenders can make their own set of guidelines regarding the approval process which results in faster decision making, shorter loan timelines and faster loan processing. 

2. Flexibility in loan terms

Hard money lenders can make their own set of criteria to fund a real estate investment. Banks and other conventional sources are limited by guidelines which they need to adhere to making the process rigid. 

Hard money lenders on the other hand just need to evaluate the equity in the property, ensure that the borrowers have enough cash on hand to make the monthly payments, and a reasonable exit strategy for the loan approval to take place. 

3. Loans based on collateral 

In case of hard money loans, the property value is the only consideration for the loan approval and funding to take place. Banks have a list of red flags that prevent them from approving a loan. This includes bad credit score, history of foreclosures, short sales, loan modifications, and bankruptcies. 

With collateral based loans, the credit score you have doesn’t dictate whether or not the financing will be approved. Private lenders can opt to base the loan amount on the after repairs value (ARV) of the property if it happens to be higher than the purchase price making it a lucrative option for real estate investors.

4. Low underwriting requirements

Banks and traditional funding sources like credit unions have set underwriting guidelines that include credit checks, bank statements, completion of taxes, credit limits. Hard money lenders don’t use a standard underwriting process. Instead, each deal is evaluated at an individual level before the loan application is processed. 

The private lenders may choose to reduce the underwriting or eliminate it altogether. Lower underwriting requirements accelerates the time for approval while adding flexibility to the process. 

5. Loan approvals for riskier properties 

Banks are typically risk averse lenders. Distressed properties or ones that require repairs fall beyond their lending criteria. This makes it difficult for real estate investors who are looking to fix-and-flip houses for profit to get a conventional loan from a bank. 

Hard money lenders on the other hand recognize the fact that, even though it is a riskier proposition, such properties often offer high profit margins. The fix-and-flip loan amount they approve is also based on the estimated after-repair value of the property instead of the current valuation making it a lucrative deal for the borrowers as well. 

6. Low documentation requirements

Conventional loan applications are document intensive. From tax history and pay stubs to credit score, a number of documents need to be submitted with the application for the processing to take place. Not only does compiling these documents take time, scrutiny of the same by the loan officer is also time consuming. 

In case of hard money loans, there is minimal documentation required. Hard money loans are also a boon for people who are self employed or those who do not have the bank mandated two years of employment history to get a loan. 

7. Relationship based lending

Hard money lenders aren’t just a source of procuring capital to finance your real estate deals. They can actually act as partners in real estate investments with the required insights and local knowledge.

By offering guidance on deals and connecting you with the right contacts like reputable contractors, title companies, real estate agents and property stagers, they can actually play an important role in your success in the real estate market that you choose to invest in. 

Having a working relationship with a hard money lender can also get you additional benefits such as faster closings and deals with lower origination fees and interest rates when you approach them for subsequent funding. 

Cons of Hard Money Loans

1. Higher interest rates

Hard money loans are typically higher-interest loans because they are riskier for the lender.  Banks can afford to offer lower interest rates as they typically lend on low-risk properties and offer long term loans. 

Since hard money loans are typically more riskier and short-term, there is also a greater down payment that is required to be made.This helps lenders to reduce the risk and also incentivizes the investors to complete the projects they start out on. This makes hard money loans a costly affair for a first-time real estate investor.  

2. Higher origination fees

In addition to the frequently double digit interest rates, there is also the involvement of origination fees that adds to the overall expenses when taking a hard money loan. Points or loan fees are the cost that a private lender charges to make the loan. 

A hard money lender may charge anywhere from 1-5 percent of the loan amount as origination points. Borrowers with a history of transactions and more experience in real estate investments can get loans at lower origination fees which again puts novice real estate investors at a disadvantage. 

3. Shorter duration loans

Hard Money Lenders specialize in short-term loans that last at max few years. Borrowers need to make sure they have an exit strategy or way to repay the loan either through refinancing, the sale of another asset, or the sale of the property for which they have taken the loan.

While the lenders are generally conducive to loan extensions if the need arises, borrowers may need to pay even higher interest rates or an extension fees adding to the cost of the loan. 

4. Riskier than conventional loans

Since hard money loans have higher interest rates and are offered for short term basis, they are inherently riskier. Hard money loans can lead to high financial burdens if not entered wisely. In the worst case scenario, since the property is collateral in case of such loans, in case of inability to repay the loan, you are at risk of losing the property.   

5. High equity requirements

Hard money lenders require sufficient equity in the property to act as security for the loan. It is normal for hard money lenders to ask for upto 20-30 percent of the property value as down payment. In case of commercial hard money loans, this figure may go up to 40 percent.

The high equity requirements reduce the chances of the lender defaulting on the loan and gives them the incentive to complete working on their project. 

When does taking a hard money loan make sense?

A loan is a sensible decision when the value of borrowing the money exceeds the cost for which you had to pay to get the loan. Essentially, if you need faster access to capital for funding your real estate projects for a short period of time, hard money loans make the most sense. 

If you are looking to fix-and-flip a property for profit, hard money lenders are going to be your best bet. The same applies if you need funds to purchase properties to set up a rental portfolio or need a landlord loan to renovate or refurbish your existing investments, a hard money loan makes perfect sense. 

Even if you happen to be a first time home buyer and don’t have the perfect credit score or income history to get approved for a conventional bank loan, hard money can come in handy. However you would need to get it refinanced in the future at better interest rates for it to make financial sense in the long term. 

Hard money loans can prove to be a valuable asset in your real estate journey if the pros of applying for one outweigh the cons of it. 

With a track record of successful lending across the US and local expertise as real estate investors ourselves, 14th Street Capital is the one stop destination for all your funding needs. Get in touch with us today.