A hard money loan is a short-term financing option used to fund the purchase of an investment property. Hard money loans are commonly used by real estate investors for fix-and-flip projects, renovations of rental properties, or simply to facilitate the speedy purchase and transfer of real estate.
Who is a Hard Money Loan Right For?
Hard money loans are right for both short-term investors and long-term investors. Specifically, hard money loans are used by:
Fix-and-Flippers – Short-term investors who will purchase, renovate, and sell a property within 12 months.
Buy-and-Hold Investors – Long-term investors who will purchase a house in poor condition, renovate it, and then rent it out to tenants.
Portfolio Investors – Long-term investors who would like to grow their portfolio of rental properties (typically 4+).
Let’s take a look at the different ways short-term investors and long-term investors use hard money loans.
Fix-and-flip investors are short-term real estate investors who look to purchase, renovate, and sell a property within 12 months. Hard money loans are good for short-term investors because they can finance both the purchase and renovation of a home in a single loan, have a short loan term, and offer interest-only payments.
For example, many short-term investors look for houses in poor condition, that if renovated, could sell for more than their current fair market value (FMV). These houses are typically found at short-sales, foreclosure auctions, as well as with lender-owned REO properties.
Using a hard money loan, fix-and-flip investors finance the initial purchase of the house as well as the necessary renovations. Fix-and-flippers typically obtain hard money loans equal to a percentage property’s after-rehab-value (ARV), which is the expected FMV after all renovations have been made.
Once a property is purchased with the initial funds from the lender, investors start their renovations, receiving renovation financing from hard money lenders in stipends or “draws.” This means that fix-and-flippers typically have to float rehab costs until they receive funds from the lender.
During renovations, fix-and-flippers pay a hard money lender interest-only payments. At the end of the hard money loan, fix-and-flippers repay the loan through the sale of the house for a profit. If you want to dig deeper into this, read our detailed example of how rehab loans work.
Buy-and-hold investors are real estate investors who purchase and renovate rental properties. Buy-and-hold investors typically use hard money loans when an investment property isn’t in good enough condition for a traditional mortgage.
This is because traditional lenders won’t issue conventional mortgages for houses in poor condition. However, dilapidated houses provide as much upside for long-term investors as they do for short-term investors.
To circumvent this funding problem, long-term investors use hard money rehab loans to finance the initial purchase and renovations of the asset. Once renovations are made, long-term investors rent out the property, refinance the improved home with a conventional mortgage, and use the money to pay off the hard money loan.
Sometimes a buy-and-hold investor who may qualify for permanent financing will need access to the financing right away, like when they’re competing with all-cash buyers at real estate auctions. In these cases, long-term investors rely on hard money loans for a quick approval process and a fast funding time.
Portfolio investors are long-term investors who invest in multiple properties at the same time. While these long-term investors prefer conventional mortgages, many banks and lending institutions only loan out between 4 – 10 conventional mortgages to a single person.
So, if a portfolio investor meets his or her conventional mortgage limit, the only financing options available are to either purchase a house all-cash, obtain a blanket mortgage, or use a hard money loan. Since most portfolio investors are highly levered to begin with, they typically rely on a hard money loan to make the additional property purchases.
This means that a portfolio investor might use a hard money loan to purchase houses in both good and bad condition. If the condition is poor, hard money lenders issue loans as a percentage of the house’s after-rehab-value (ARV). If the condition is good, hard money lenders issue loans as a percentage of a house’s loan-to-value (LTV) ratio, which is similar to the loan limits set by conventional mortgages.
Similar to buy-and-hold investors, portfolio investors sometimes use hard money loans specifically because they need the speed to compete with all-cash buyers. Finally, some portfolio investors might not meet other conventional mortgage qualifications – such as the minimum credit score – and therefore need to rely on hard money loans before meeting qualifications and refinancing at a later date.
Hard money loans have many differences when compared to a conventional mortgage. For example, conventional mortgages are issued by banks, have strict loan requirements, a longer time to approval, a longer loan term, low interest rates and fees, and fund single-family homes, apartments, condos and multi-family units in good condition. Conversely, hard money loans are issued by private money lenders have fewer loan requirements, a short approval time and loan term, comparatively higher interest rates and fees, as well as fund single-family homes, apartments, condos, and multi-family units in most conditions.