Hard money loans or private money loans are used when traditional lenders are taking too long or are not interested in lending. This is probably the reason that hard money loans are also referred to as the ‘last resort.’
The term hard money is used because, unlike conventional loans; this loan relies on a property that is kept as collateral by the investor. For traditional investors such as banks, your ability to repay is what matters, which is why they are more interested in your credit history and income. With hard money loans, however, the investor is typically interested in the asset, so that in case things go haywire, the investor can sell the asset.
Hard money loans make sense when people need short term loans such as in the case of fix-and-flip the property, where investors buy a property wait for the value to increase and then sell it. Taking hard money loans for the long term does not even make sense because they have higher interest rates.
People prefer hard money loans despite the higher rate because of the speed of approval, flexibility and the chances of approval because the lender will easily lend you the amount equal to the value of the property.
There are both advantages and disadvantages associated with hard money loans, the biggest disadvantage being the high-interest rate. Most people make the mistake of only taking interest rate into account when borrowing, and they often fall into the trap of cheap hard loan. However, there are several other costs associated with it. If you are contemplating taking hard money loan, here is what it actually costs:
3 Benefits of Hard Money Loan and Conditions
1. There are no hard and fast rules
The basic thing that you need to understand is that when it comes to rates, there are no rules that lenders follow. The rates can vary from 7.5% to 15% and from 3 months to 36 months. The rates usually depend upon the risk involved, the type of asset and the experience of the borrower in case it is the fix-and-flip situation.
Interest rates tend to be higher for a higher loan-to-value ratio. This is because it compensates the investor for the higher risk. For example, a property that is located in a less desirable area will have a higher interest rate. These rates are not overlooked by the government or any other authorities; they are completely on the discretion of the lender.
2. Hidden costs
Hard money loans come with other hidden costs other than the apparent interest rate. Other costs include points, underwriting fees, appraisal fees, referral fees, and pre-payment penalties.
Points: These are basically charges that are for originating the loan. They are calculated as the percentage of the total amount of the loan. The percentage varies between 2-4 percent. The actual percentage depends upon the loan-to-value ratio, the risk involved, and the interest rate charged.
Underwriting fees: This is the charge to process the documentation and the entire application.
Appraisal charges: This is the fees that the borrower has to pay to the property appraised by a licensed appraiser.
Referral fee: This is not a mandatory fee. It is only applicable when you are referred by a realtor or a broker.
Third party fee: Other third-party costs may include escrow, title insurance, and notary. These costs depend on the loan amount and the state that you are residing in. A Texas hard money lender will charge you something different than hard money lender in Virginia.
3. Applying for a hard money loan
No doubt, hard money loan is less of a hassle than the traditional one. However, there are certain rules and minimum qualification criteria required to acquire the loan. The investor’s primary focus is on your project. If you are investing in a fix and flip project, for example, the investors will be more interested in your success rate.
Some of the things that your lender may need include a FICO rate of at least 550. FICO is a score that takes into account your credit history, accounts owed and credit mix. The score ranges from 300 to 850. Scores above 650 show a good credit history.
Other than they usually need bank statements, purchase contracts and renovation bids in case of fix and flip. Hard money loans are processed quickly, i.e. within 10 to 15 days.
Once you get an offer from the lender, always get it checked from a lawyer so that you are covered legally.
Hard money loans may seem a lifesaver when you cannot get credit from conventional sources. However, before you get desperate, to do extensive research. Check all the pros and cons associated with the loan. Ask for all the hidden costs; don’t fall for cheap rates. Taking a leap of faith might not be the best strategy in this case.
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No matter the hassle for traditional loans, I’ll still prefer them because they come with less risk and can be extended.