DEFINITION of Hard Money Loan
A hard money loans is a loan of "last resort" or a short-term bridge loan. Hard money loans are backed by the value of the property, not by the credit worthiness of the borrower. Since the property itself is used as the only protection against default by the borrower, hard money loans have lower loan-to-value (LTV) ratios than traditional loans.
BREAKING DOWN Hard Money Loan
Hard money loans carry interest rates even higher than traditional subprime loans. Since traditional lenders such as banks do not make hard money loans, hard loan lenders are sometimes private individuals that see value in this type of potentially risky venture. Hard money loans may be used in turnaround situations, in short-term financing, and by borrowers with poor credit but substantial equity in their property. A hard money loan could be used as a way to stave off foreclosure.
How Hard Money Loans Are Used in Real Estate
Hard money loans may be sought by property flippers who plan to renovate and sell the real estate that is used as collateral for the financing. This option may be appealing because the property owner expects to resell the real estate within one year if not sooner and pay off the loan. The higher costs of a hard money loan are offset by some of the advantages they offer to the borrower.
The approval process for a hard money loan may be much quicker than applying for a traditional loan through a bank. The private investors who back the loan may make a faster decision based on the value of the property used as collateral. The lenders may not be as concerned about receiving repayment because there may be an even greater value and opportunity for them to resell the property themselves if the borrower defaults. Hard money lenders might not use traditional underwriting process, which can allow for adjustments to be negotiated regarding the repayment schedule for the loan. This could afford the borrower more opportunities to pay back the loan during the window of time available to them.
Hard money lenders might elect to not provide financing for owner-occupied residence because of regulatory oversight and compliance that may be needed to complete the financing.
The costs of hard money loans to the borrower are traditionally higher compared with financing available through banks or government lending programs. The increased cost is a tradeoff for faster access to capital, less stringent approval process and the higher risk that the lender is taking by offering up the financing.