Real estate is among the most valuable assets that most consumers will ever purchase, and finding financing can be tricky. Luckily, there are several options available that you may not even be aware of. One of the most popular for real estate investors is called a hard money loan. A hard money loan allows buyers to effectively compete with cash offers without laying out so much cash, allowing them to complete more projects than they otherwise could.
A hard money loan is simply a short-term loan secured by a piece of real estate as collateral. Investors frequently use the properties they are preparing for resale as collateral, but you can generally choose a different property if you wish. The amount you can borrow is determined by the collateral's projected After Repair Value (APV), with 75 percent as an industry standard for how much you can get. Competing options generally use a property's current value, meaning that hard money loans provide more capital for the same collateral. You may also qualify for reimbursements when you lay out cash for repairs.
The real key is a hard money loan's repayment structure. Early payments only cover a minimal amount of interest, ensuring that the loan does not compromise an investor's cash flow as they prepare a property for resale. Once the prescribed term is up (generally one year, though most lenders are flexible), a balloon payment covers the rest of the balance. Investors generally flip the property before this final payment is due, using the proceeds to cover the cost and pocketing the rest as their profit.
One of the biggest advantages of a hard money loan is the speed at which applications are approved and funded. Many lenders offer same-day approvals and funding within a week! The paperwork involved is minimal as well. This is especially important when the market is booming and sellers don't have to wait for an interested buyer to procure a traditional mortgage.
The value of your collateral is also the biggest factor in the approval process, making hard money loans a good idea for buyers with poor or no credit and/or limited income. It may also be an option for homeowners who have fallen into arrears on their existing mortgage or after bankruptcy and foreclosure proceedings have begun, situations that traditional banks won't touch. That said, it should be noted that some lenders will check your credit score as part of their due diligence.
The downsides of hard money loans include higher interest rates and limited regulation. Since most hard money lenders are private individuals as opposed to large financial institutions, they are taking on substantial personal risk and price that into their interest rates. Furthermore, the Dodd-Frank Act does not apply to hard money loans, though some states regulate them through separate legislation. It is advisable to review your state's current rules before choosing a hard money loan.
Hard money loans aren't as well-known as traditional mortgages, but they offer a lot of advantages to real estate investors who don't want to wait on a bank for months every time they purchase a property. Looking into them could be just what you need to invest in more properties!