There are multiple financing options for your business. You can seek out short term loans and microloans if you need a small influx of cash quickly, or you can take out large-scale loans to expand and scale your business. Each loan option comes with its own terms and restrictions on the money.
Another loan option that is particularly popular in real estate is the hard money loan. Hard money lenders use collateral like property to back the loan. If the borrower is unable to repay the lender, they can seize and sell the collateral.
You can work with money lenders to secure the funds you need with a short-term payback period. Learn more about these loans and the lenders who issue them.
Hard money lenders don’t look at the credit of the applicant. Instead, they are more interested in the property the applicant is borrowing against. The financial provider wants to ensure the collateral is worth the risk of lending before they approve the loan.
If the borrower can’t pay back the loan, the lender can seize the property. For example, in real estate investments, if a property is built over a sinkhole or lacks any real value, then the lender is unlikely to issue the loan.
Hard money loans are most frequently used by home flippers who want to take worn or damaged property and improve it for a profit. In this case, the land has potential and maybe even a structure built on it.
The home flipper will renovate the property and resell it—typically within a year or two. This is what makes the risk of the hard money loan worth it: the borrower gets the loan to purchase and flip the property while netting the difference when they resell it, and the lender knows that they’ll retain the property if the loan is not repaid.
You can also find people in need of hard money loans outside of the real estate field. These are often considered short-term bridge loans and require substantial collateral to secure the loan.
Hard money lenders typically require a small down payment. This up-front payment is considered their “buy-in” to the loan and ensures they have personal financial assets at stake, too. The down payment or buy-in adds more accountability to the borrower and helps mitigate loan delinquency, which lowers the risk to lenders.
For example, lenders may require real estate investors to put in 10% to 50% of the property value for a down payment. The amount required will typically depend on the riskiness of the property.
Some hard money lenders will issue a loan without a down payment, but they might charge other fees or have stricter restrictions to ensure borrowers pay the money back.
Hard money loans are considered riskier than traditional loans, which is why they are more expensive. Borrowers can expect to pay interest rates of 10–15%, depending on the lender.
The interest rate might also depend on how much your hard money lender is willing to give you. Most lenders look at the loan-to-value ratio (LTV) when issuing funds. They will typically issue 65–75% of a property’s current value. This limit is another reason why borrowers need to be ready for a down payment: lenders won’t cover the full cost of the property.
Some hard money lenders don’t use the LTV model and instead look at the after-repair value (ARV). This number is the estimated value of the property after it has been flipped. If your lender calculates your loan based on ARV, you will likely get more money. However, this loan is riskier. There is no guarantee that the home will have that market value when the renovations are complete. As a result, these interest rates are typically much higher, close to 18% with extra points added.
For example, let’s say a flipper wants to buy a property that is listed at $200,000. Using the LTV model, their loan would be around $150,000, which means the flipper needs to bring in $50,000 of their own money plus funds for renovations.
If the lender uses the ARV model, they might place the flipped value of the house at $300,000. This method brings the loan up to $225,000. The borrower now has more money to work with but must cover these extra funds through the resale.
Banks typically don’t offer hard money services, which means real estate professionals and other entrepreneurs who need hard money loans will need to turn to private investors. Hard money lenders are often individuals who support business owners or private companies specializing in hard money lending.
Hard money loans are known for being fast. While it might take up to 30 days to get a traditional loan through a bank, hard money loans can get approved within a few days. This speed allows real estate investors to move quickly when a property hits the market. Traditional banks don’t have enough time to evaluate the level of risk that comes with a property, which is why they don’t get involved in hard money systems.
Working with a hard money lender may be your best bet if you run your business in a competitive real estate market. If you have a solid down payment already, you can take steps to build it up and flip it. However, if this is your first foray into real estate, a hard money loan might be too expensive or risky for your needs.
Shop around to understand the costs of different hard money lenders that you want to work with. This can help you set an investment and renovation budget to start flipping homes for profit.
While a hard money loan might seem like a strong real estate option, other funding options are available if you operate in another industry. At Lendio, we match borrowers with all kinds of loan types, from startup funding to large-scale loans. Visit our online lending center to learn more and to find a financial provider that can help you.