There are different ways of securing credit to fund your business or personal projects if you lack the funds to do so on your own. If you’re trying to raise the money quickly and have real estate assets to use as collateral, a hard money loan may be the right choice for you. Let’s explore the basics of a hard money, its benefits, what you can do to secure such a loan, and what happens if you default.
What Is a Hard Money Loan?
A hard money loan is a short-term loan, or bridge loan, secured by a real estate asset or property. Typically, hard money loans are provided by private lenders and are primarily used in real estate transactions. Being short-term loans, the lending period typically last for one year — but could go up to five years in some cases — and interest rates are much higher compared to other conventional loan types. For these reasons, you would seek a hard money loan as a temporary solution while pursuing permanent financing.
Lenders of hard money loans determine how much they can invest using the loan to value (LTV) ratio. The LTV ratio is the total loan amount divided by the value of the asset used as collateral. Typical, hard money loans are offered at an LTV of 65% to 75%.
What Makes a Hard Money Loan Different?
There are a few differences between a hard money loans and other conventional loans. First of all, hard money lenders don’t necessarily take your credit score or debt to income history into account; hence, they are not primarily concerned with your ability to repay the loan. Instead, the value of your collateral is usually the basis of the loan.
Secondly, hard money loans are not provided by banks or other commercial financial institutions. Moreover, hard money loans don’t involve as much bureaucracy as conventional loan types.
What Happens If I Default On a Hard Money Loan?
There are a number of things that could happen if you default on a hard money loan, based on the kind of contract you sign with the lender. Let’s explore some of them below:
Your Credit Score Will Go Down
A hard money loan may be unconventional, but it still operates by some conventional rules. If you default on a hard money loan, your credit score will take a hit, sometimes going down by as much as 160 points.
Your Interest Rate Could Go Up
Some hard money lenders will include a default clause in the loan agreement to significantly increase your interest rates whenever you default on a payment. While this will help the lender recover their money more quickly, it could make it more difficult for you to repay the loan.
You Could Hand Over the Deed in Lieu of Foreclosure
Some lenders will be happy to take over your investment without foreclosing on the collateral. What this means is that you can hand the property you bought or invested in over to the lender. When you do this, ensure that the lender also signs “a release of lien,” which frees you of any outstanding debt. Handing over the deed in lieu of foreclosure is a more favorable outcome because it prevents a foreclosure from negatively affecting your ability to get loans in the future.
The Lender Could Foreclose On Your Property
As with banks and other commercial lenders, a hard money lender could foreclose on the real estate asset you used as collateral if you default on the loan. They may sell the property and use the funds to pay off the outstanding balance. This is usually a long process and costs the lender a lot of money.
You should note that if your property gets foreclosed on, you forfeit any portion of the loan that has already been repaid. So, not only will you lose your asset, you will also lose your money. Some lenders may also require that the value of your property doesn’t go below a certain value. If it does, they could foreclose on it.
The Lender Could Sue
In some cases, a foreclosure requires the lender to file a suit against you in court. On the other hand, if for any reason the funds obtained from the sale of your property are not enough to cover the cost of the loan, the lender could take you to court to recover the rest of the funds.
When Should I Consider a Hard Money Loan?
Despite these concerns, if you need some quick cash and are pressed for time, a hard money loan is still a good option. It’s also a great choice if you’re looking to purchase a property so you can sell it for a profit in the short term — a practice known as “fixing and flipping.” In addition, consider a hard money loan if your credit score is not quite perfect or if you’re financing a construction project or land purchase.
How Do I Obtain a Hard Money Loan?
You can obtain a hard money loan from a private investor or lender. Here’s what you need to do:
Save Up for a Down Payment
You should have at least 25% to 35% of the loan value saved up as a down payment before you start looking for financing. This will help you save time when you eventually find prospective investors for your project.
Prepare a Loan Proposal
Prepare a proposal to show how profitable your venture is. Include relevant documents to show the value of the property you want to buy, its growth potential, and financial projections to back up your position. This will reassure the lenders, who may be more willing to let go of their money.
Find the Right Lender
Research the available options. Ask other professionals in your line of business and look at websites and online reviews to glean how trustworthy your prospective lender is. Note that some lenders may only finance certain types of projects, so find out as much as you can before settling on someone.
Make a Repayment Plan
Decide how often you want to make payments. Would you rather go with a monthly payment or one lump sum when the loan tenor expires? Your financial position and income options will determine what option is best for you.
A hard money loan is a great way to finance a project if you have physical assets and an excellent cash flow. Take care not to default on your loan so you don’t lose your money and assets.