What Is a Hard Money Loan?

A hard money loan is a loan of "last resort" or a short-term bridge loan. Primarily used in real estate transactions, its terms are based mainly on the value of the property being used as collateral, not on the creditworthiness of the borrower. Since traditional lenders, such as banks, do not make hard money loans, hard money lenders are often private individuals or companies that see value in this type of potentially risky venture.

The cost of a hard money loan to the borrower is typically higher compared to financing available through banks or government lending programs, reflecting the higher risk that the lender is taking by offering the financing. However, the increased expense is a tradeoff for faster access to capital, a less stringent approval process, and potential flexibility in the repayment schedule.

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. Since it can be issued quickly, a hard money loan can be used as a way to stave off foreclosure.

How a Hard Money Loan Works

Hard money loans may be sought by property flippers who plan to renovate and resell the real estate that is used as collateral for the financing – often within one year, if not sooner. The higher cost of a hard money loan is offset by the fact that the borrower intends to pay off the loan relatively quickly – most hard money loans are for one to three years – and by some of the other advantages they offer.

One such advantage: The approval process for a hard money loan is often much quicker than applying for a mortgage or other traditional loan through a bank. The private investors who back the hard money loan can make decisions faster because they often don't make credit checks or examine a borrower's credit history – the steps lenders usually take to investigate an applicant's ability to make loan payments. These investors aren't 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.

Another advantage: Since hard money lenders don't use a traditional, standard, underwriting process, but evaluate each loan on a case-by-case basis, applicants can often negotiate adjustments regarding the repayment schedule for the loan. Borrowers can angle for more opportunities to pay back the loan during the window of time available to them.

A hard money loan, usually taken out for a short time, is a way to raise money quickly, but at a higher cost and lower LTV ratio.

Downsides to Hard Money Loans

Since the property itself is used as the only protection against default, hard money loans usually have lower loan-to-value (LTV) ratios than traditional loans do: around 50% to 70%, vs. 80% for regular mortgages (though it can go higher if the borrower is an experienced flipper).

Also, their interest rates tend to be high. Of course, one always pays more for a short-term loan than for a long-term one, but hard money loans' rates can be even higher than those of subprime loans. As of January 2019, hard money loan rates were ranging from 7.5% to 15%, depending on the length of the loan. In comparison, the prime interest rate was 5.5%.

Another drawback: Hard loan lenders might elect to not provide financing for an owner-occupied residence because of regulatory oversight and compliance rules.