Using Hard Money Loans for Real Estate Investments

Investing in real estate can be a lucrative avenue for building wealth, and it’s an effective way to diversify your portfolio. Real estate investment trusts (REITs) and real estate crowdfunding allow you to invest passively, but some investors may prefer to own property directly.

If you are not comfortable parting with a substantial sum of money to buy real estate, a cash loan may be the solution. Although this type of loan has advantages over traditional financing, it has potential drawbacks. A certain capital buffer is always required.

How hard money loans work

Hard money loans, sometimes called bridging loans, are short-term loan instruments that real estate investors can use to finance an investment project. This type of loan is often a tool for real estate flippers or property developers whose goal is to renovate or expand a property and then resell it for a profit. Hard money loans are issued by private lenders rather than traditional financial institutions such as banks.Inasmuch asInasmuch as

Unlike traditional bank loans, the ability to obtain cash financing is not determined by the borrower’s creditworthiness. Instead, hard money lenders use the value of the property itself to determine whether to grant the loan. Specifically, lenders focus on “after repair value,” or ARV, which is an estimate of how much the property is worth after the renovation or development phase is complete.Inasmuch asInasmuch as

The inconvenients

Hard money loans are not a perfect financing solution. There are two main drawbacks to consider:

  • Cost Hard money loans are convenient, but investors pay a price to borrow this way. The rate can be up to 10 percentage points higher than for a conventional loan. Origination fees, loan servicing fees and closing costs are also likely to cost investors more.
  • Shorter repayment period The purpose of a hard money loan is to enable an investor to get a property 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 ​​when the property will become profitable to ensure that you will be able to repay the loan in a timely manner.

Advantages

There are several good reasons to consider getting a hard money loan instead of a conventional mortgage from a bank. Here are the main advantages that this loan option offers to investors:

  • Convenience Applying for a mortgage takes time, especially thanks to the new mortgage regulations introduced under the Dodd-Frank Act. Closing a loan can take months, putting investors at risk of losing a particular investment property. With a hard money loan, it is possible to obtain financing in a few weeks. This is important if you are funding a large scale development project and cannot afford to deviate from the completion schedule.
  • Flexible terms Because hard money loans are offered by private lenders, it is possible for investors to have more leeway in negotiating loan terms. You may be able to tailor the repayment schedule to your needs or get certain fees, such as origination fees, reduced or eliminated during the underwriting process.
  • Collateral With a hard money loan, the property itself usually serves as collateral for the loan. But again, lenders can give investors some leeway here. Some lenders, for example, may allow you to secure the loan using personal assets, such as a retirement account or residential property you own.

The essential

Hard money loans are ideal for high net worth investors who need to obtain financing for an investment property quickly, without any of the paperwork that comes 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 for a hard money loan or shorten the repayment period too much, it can affect the profitability of your real estate project in the long run.

James V. Hayes