Investing in real estate can be a lucrative avenue for building wealth, and it’s an effective way to diversity your portfolio. Reeal estate investment trusts (REITs) and real estate crowdfunding allow you to invest passively, but some investors may prefer to own property directly.
If you’re not comfortable parting with a substantial amount of cash up front to purchase real estate, a hard money loan may be the answer. While this type of loan has advantages over traditional financing, it does have potential downsides.
Hard money loans, sometimes referred to as bridge loans, are short-term lending instruments that real estate investors can use to finance an investment project. This type of loan is often a tool for house flippers or real estate developers whose goal is to renovate or develop a property, then sell it for a profit. Hard money loans are issued by private lenders rather than mainstream financial institutions such as banks.
Unlike traditional bank loans, the ability to obtain hard money financing isn’t determined by the borrower's creditworthiness. Instead, hard money lenders use the value of the property itself in determining whether to make the loan. Specifically, lenders focus on the “after repair value,” or ARV, which is an estimate of what the property will be worth once the renovation or development phase is complete. (See also: How to Value a Real Estate Investment Property.)
Hard money loans aren’t a perfect financing solution. There are two primary drawbacks to consider:
There are several good reasons to consider getting a hard money loan instead of a conventional mortgage from a bank. Here are the main benefits this lending option offers to investors:
Hard money loans are a good fit for wealthy investors who need to get funding for an investment property quickly, without any of the red tape that goes along with bank financing. When evaluating hard money lenders, pay close attention to the fees, interest rates and loan terms. If you end up paying too much for a hard money loan or cut the repayment period too short, that can influence how profitable your real estate venture is in the long run.