Investing in real estate can be a lucrative way to build wealth and it is an effective way to diversify your life folder. Real Estate Investment Trusts (REITs) & Real Estate Crowdfunding & allow you to invest passively, but some investors May prefer to own the property outright.
If you’re not willing to give up a lot of cash to buy real estate, a hard money loan might be the answer. While this type of loan has advantages over traditional financing methods, there are also potential disadvantages. Certain capital buffers are still required.
How hard money loans work
Hard money loans, sometimes called bridge loans, are short-term loan vehicles that real estate investors can use to finance investment projects. This type of loan is usually a home flip or a real estate developer whose goal is to renovate or develop a property and then sell it for a profit. Hard money loans are issued by private banks rather than mainstream banking financial institutions such as banks.
Unlike traditional bank loans, the ability to obtain hard money financing does not depend on the borrower’s ability and creditworthiness. Instead, hard money lenders use the value of the property itself when deciding whether to issue a loan. Specifically, lenders focus on “post-rehabilitation value,” or ARV, which is an estimate of the property’s value after the renovation or development phase is complete.
Hard money loans are not a perfect financing solution. There are two main drawbacks to consider:
- Costs – & Hard money lending is convenient, but there is a cost to investors borrowing in this way. Interest rates can be 10 percent higher than traditional loans. Origination fees, loan servicing fees, and; closing costs; may also cost investors more.
- Shorter repayment period –; the purpose of hard money loans is to allow investors to acquire properties that are ready to market as quickly as possible. As a result, these loans have much shorter repayment terms than traditional mortgages. When choosing a hard money lender, it is important to have a clear idea of how long the property will be profitable to ensure you can repay the loan promptly.
There are several good reasons to consider getting a hard money loan instead of a conventional mortgage loan from a bank. Here are the main benefits that this type of loan brings to investors:
- Convenience – Applying for a mortgage can be time-consuming, especially due to new regulations implemented as part of the Dodd-Frank Act for mortgages. It can take months to complete a loan, which can expose investors to the loss of a certain investment Sexual real estate risks. With hard money loans, funding is possible within weeks. This is important if you are funding a large-scale development project and cannot afford deviations from schedule to completion.
- Flexible terms – Since hard money loans are provided by private lenders, investors are likely to have more room to negotiate the terms of the loan. You may be able to customize the repayment arrangement according to your needs or charge certain fees, such as origination fees, to reduce or eliminate the underwriting process.
- Collateral – For hard money loans, the property itself usually acts as collateral for the loan. Lenders may give investors a little wiggle room here, though. For example, some lenders may allow you to use personal assets such as a retirement account or a residential property you own to get a loan.
Hard money loans are ideal for wealthy investors who need quick access to investment property funds without any of the red tape associated with bank financing. When evaluating hard money lenders, pay close attention to fees, interest rates, and loan terms. If you end up paying too much on a hard money loan or shortening the repayment period too short, this could affect the profitability of your real estate business in the long run.