When most people think about buying a home, they take out a loan from their bank or mortgage lender. But what if your credit doesn't meet the guidelines of traditional lenders (especially now that they are precluded from offering riskier or more expensive mortgages by recent reforms)? Or what if you want to purchase a property at a foreclosure auction but can't pay cash? What if you own 20 or 30 financed properties, making Fannie Mae and Freddie Mac loans off-limits? Or you're self-employed and have plenty of income but can't substantiate it the way lenders and regulators require? You may find yourself turning to hard money lenders.
What Is Hard Money Lending?
Hard money, also known as private money, refers to loans made by private individuals or groups of investors. These loans may be facilitated by a firm that works like a mortgage brokerage and earns a commission for putting the transaction together, collecting payments and issuing tax forms.
They may also be obtained directly from individual lenders (the American Association or Private Lenders is an industry group and hard money business listings can be found on their Web site). Viewed by many as a loan of last resort, interest rates can range from ten to 20 percent, and fees include several points.
Advantages of Hard Money Loans
Not everyone who chooses hard money has bad credit. Some just have a need for speed. If you're real estate investor who likes to fix and flip, hard money might be your way of life. A 15 percent rate on a loan you only have for six months that makes possible an investment returning 30 percent doesn't seem too bad.
Underwriting is cursory, there is minimal paperwork and zero red tape. You simply have to pitch an investor and find one agreeable to your needs.
One of the biggest advantages of hard money loans is that loans are made based on the value of the home and typically not the creditworthiness of the borrower. Because you're dealing with private individuals, terms can be very flexible if you're willing to pay for them.
Individuals with poor credit who cannot qualify for a traditional mortgage can leverage private money with a real estate contract to purchase property that would otherwise be out of their reach.
Disadvantages of Hard Money Loans
Don't expect to get a hard money loan with nothing down. Or even 20 percent down. Hard money lenders routinely require 30 to 50 percent down, and even more sometimes when they finance people with really bad credit. (Investors with good credit and verifiable income can do better.) That's because they expect you to default and they want to make sure they're covered if you do.
The downside of buying a home with hard money is the cost. Expect to pay double-digit interest rates (10 to 18 percent) and several points in upfront fees for a hard money loan. Lenders charge such high fees because most loans are repaid quickly – so a high interest rate doesn't necessarily net them much income.
Hard money loan terms often include a large balloon payment. If your loan includes a balloon payment, plan on being able to sell, refinance or lose the property before the end of the loan term. If you default on the loan, the private investor can foreclose just like a traditional mortgage lender.
Remember that if you're willing to pay for more flexible terms, you might be able to get a private investor to structure your hard money loan more like a traditional mortgage. For the credit challenged, leveraging hard money could get you into homes that would otherwise be out of your reach with a traditional mortgage lender.