What Are Hard Money Loans and How Do They Work? | LendingTree (2024)

FAQs

Is a hard money loan a good idea? ›

Hard money loans are risky. This is primarily because they come with higher interest rates and shorter repayment terms, and they have limited regulations compared to typical mortgages. This means that you, as the borrower, would have very little protection or options if you were to need help repaying the loan.

Here's how a typical hard money loan works: The borrower wants to purchase a fixer-upper for $100,000. The estimate for renovation costs is $30,000, and it's projected the rehabbed property can be sold for $180,000. In this example, the hard money lender will lend 70% of the home's projected value after repairs.

Unlike a traditional home mortgage, hard money lenders typically only charge interest on a monthly basis, which means you don't actually pay any money toward the principal loan amount at each monthly payment cycle.

Rates for hard money loans can vary, but the average interest rate is generally between 10% and 18%, which is significantly higher than a conventional loan. On top of that, other costs are often associated with these types of loans, including points and origination fees ranging from 2% to 6%.

While not all hard money loans are reported, those that are can either positively or negatively affect your credit score, depending on your payment history. The key lies in choosing a lender who aligns with your financial goals and understands the nuances of credit reporting.

A hard money loan relies on real estate equity. There are no credit score requirements and loan decisions happen quickly. Although higher risk means a higher interest rate, hard money loans can be beneficial and are often the only way to take advantage of investment opportunities.

Hard money refers to loans obtained from private investors or companies, while cash refers to actual physical currency or funds readily available in a bank account. Here are the key distinctions between hard money and cash: 1.

Some hard money lenders charge interest-only payments, meaning you don't pay any money toward the principal loan amount monthly. Instead, you pay back the full principal amount at the end of the loan cycle. So, while your interest rate is higher, you generally pay less interest over time for a hard money loan.

Hard money loans are a form of short-term financing, with the loan term lasting between 3 and 36 months. Most hard money lenders can lend up to 65% to 75% of the property's current value, at an interest rate of 10% to 18%.

Can you pay off a hard money loan early? ›

Short-term hard money bridge loans often have a guaranteed interest clause requiring three payments as a prepayment premium, after which the balance can be paid in full without penalty. You're most likely to see sliding scale prepayment penalties for longer term, 5-15 year investment property hard money loans.

Hard money loans can be a useful tool if you need financing through a less traditional route. However, these loans have high interest rates, and there is a significant amount of risk if you can't repay the loan.

Hard money loan terms are usually short, typically lasting 1 – 3 years. This fast turnaround means lenders will profit quickly – either from interest on the loan or if you default on the loan. Let's take a look at how higher interest rates come into play with hard money loans.

There are two primary drawbacks to consider: Cost – Hard money loans are convenient, but investors pay a price for borrowing this way. The rate can be up to 10 percentage points higher than for a conventional loan. Origination fees, loan-servicing fees, and closing costs are also likely to cost investors more.

The biggest risk for hard money lenders is the chance that the borrower's deal might fall through, and they cannot pay back their loan. Hence, hard money lenders use the asset as collateral, to mitigate this risk and get their money back if the borrower defaults on their loan repayments.

If you default on the hard money loan at any point, the lender takes the property and sells it, using the funds to pay off the outstanding loan. The lender would only need to sell the home for 40% – 50% of its original sales price to make its money back.

But did you know that if your hard money loan is categorized for “business” versus “investment” or “personal”, the interest payments are tax deductible? That's right—using a hard money loan could help lower your overall investment costs and put more of your profits back into growing your business.