If you are a real estate investor, hard money loans can be a very useful form of finance to have at your disposal. There are both pros and cons to using hard money loans, and how useful they can be, depends on the specific situation you are in.
For some financing requirements, a hard money loan would be a terrible idea, whilst in another shorter-term scenario, a hard money loan would be very useful.
Throughout this article, we explore the benefits of hard money loans, and also the downside associated with hard money loans, and point out which real estate investment scenarios would be well served by a heart money loan.
What Is A Hard Money Loan?
A hard money loan is a type of financing provided by private lenders rather than traditional finance and banking institutions.
These lenders lend you this money, and secure and support the loan based on some form of the underlying collateral, usually real estate.
In many cases, the normal income requirements, and background checks that banking institutions require, are waived because the loan is secured by the underlying collateral.
Given how little work is done to validate potential income to service the loan, or confirm your suitability with background checks, these loans often have quite severe penalties in the event you cannot meet the loan obligations, they have very high-interest rates, and there are often significant fees associated.
This is still a very worthwhile proposition in some real estate investment scenarios which will now be discussed in more detail.
Hard Money Loan Pros
Hard money loans are designed to be very fast. It can be done quickly as long as you have appropriate collateral to support the loan, given that verification of income and trustworthiness is not required to the same extent as it is with traditional banking institutions.
With DFW hard money lenders, from the point of inquiry to the point of receiving funds, loans can be settled in a matter of days.
As long as you have appropriate collateral to support the loan, given that verification of income and trustworthiness is not required to the same extent as it is with traditional banking institutions, these transactions can be completed rapidly.
You can often borrow a much higher amount of money with hard money loans than you could with traditional financing. Given a hard money loan is secured by the underlying asset, and not your ability to service the loan amount.
If you have a potential property deal, that is a safe and secure transaction, but you just need the funds to make it happen, hard money loans are often useful.
Hard Money Loan Cons
One of the main drawbacks of hard money loans is the high level of interest that is often charged. The risk that a hard money lender takes on, by waving the traditional income and background check requirements, needs to be compensated for with a higher than usual rate of return on their money.
This takes place in the form of a high-interest rate. The main drawback here is that if the settlement process or the deal flow drags out longer than expected, you could end up with a significant interest bill which diminishes the profitability of the investment.
High Establishment Fees
Another downside to hard money loans is that there are often significant establishment fees required at the commencement of the loan.
Again, this is due to the risky nature of the financing, and one of the key ways in which hard money lenders can operate their business profitably.
Varying Conditions Per Lender
Though hard money loans have some common characteristics, their specific conditions can vary from lender to lender.
As a result, it can take some time to deal with the different lenders, and get to know their different requirements each time.
Not Long Term
By their nature, hard money loans are designed to be a short-term source of finance.
If you need a longer-term source of finance then hard money loans are not suitable, because they are commercial loans designed for very concrete, time-limited scenarios where a large amount of capital is required for a small amount of time.
Best Use For Real Estate Investors
Hard money loans can be a very effective source of financing when used in the right way.
One of the best use cases for hard money finance is when you have a deal pending, and you are in the process of organizing longer-term finance, and it has been approved, but you are waiting for settlement.
In this case, where you definitely know the long-term finance is coming, but you need to settle the deal earlier, hard money loans can be perfect.
Other scenarios where hard money loans can be very useful are where you have a very specific deal available to you, and the deal is clearly profitable, but you need some finance to make it happen.
In these cases paying a high-interest rate, and high establishment fees are worthwhile to make the deal happen.