Finding a traditional loan on investment property might not be a good option every time. While traditional loans are known to have backed many types of investment properties, this does not mean that every commercial real estate investor will be in a position to avail themselves.
The basic challenge behind acquiring a traditional commercial real estate loan is the high qualifying standards that traditional lending institutions require a borrower to fulfil.
Does this mean borrowers who cannot qualify for a traditional loan should keep at bay from real estate investing?
Not at all. In fact, most successful investors do not count on traditional loans for backing their Investments. What do they turn to when they need quick financing at good rates? The simple answer to this is hard money loans.
Hard money loans are one of the most commonly used ways real estate investors obtain financing. In this blog, we will walk you over hard money loans and the prospective costs and benefits of buying real estate with hard money loans.
Read on to get an in-depth overview of hard money loans and decide for yourself if you can count on hard money loans for your commercial real estate needs.
What are hard money loans?
Hard money basically is the amount of money that is borrowed from a private lender. A Hard money loan is a loan given by private lenders to borrowers based on a specific contract that will lay out the terms and conditions of the loan.
There is no governing body that regulates the hard money loans, and terms are often laid down based on the mutual understanding between lender and borrower.
The borrower receives the financing while the lender receives monthly interest on the loan until the principal is paid back in full. Hard money loans are often backed by a physical asset which will be the property being purchased.
One of the major advantages of hard money loans over traditional loans is that traditional loans are heavily based on borrowers’ credit score wh. In contrast, hard money loans are based on the property value, which would be used as collateral instead of borrowers’ credit score.
This gives commercial real estate borrowers great leverage as they can now use the property value as collateral and thus do not have to struggle with the challenges of a poor credit score.
Where do you find hard money loans?
Hard money loans are provided by private money lenders or private lenders as known in common usage. Private capital investors have been providing hard money loans for many years now and are a trusted lending partner for many real estate investors.
Who do hard money loans benefit the most?
Anybody can avail hard money loans, but it mostly benefits those investors who suffer from a poor credit score and cannot get funding from traditional lending institutions. Additionally, hard money loans are also an option for many self-employed borrowers who do not have a consistent or stable cash flow to show proof of credibility to the landers.
However, despite the poor credit score, these borrowers may still have enough equity in the property intended to purchase to have the hard money lender interested in providing them a hard money loan.
Hard money loans are also applicable in special case scenarios where real estate investors who need financing to purchase distressed property types can also use them. For example, investors who want to quickly flip a property commonly used hard money loans to be processed very quickly and will meet the immediate financing need.
Costs & benefits of Hard Money Loans
Like any other type of loan – hard money loans also carry a unique set of costs and benefits. An investor needs to make an informed decision after considering both costs and benefits a hard money loan would provide.
Costs of Hard Money Loans
- High-interest rate: One of the most alluring downsides of a hard money loan is the high-interest rates. On average, hard money loans always carry a much higher interest rate than traditional loans. Private lenders charge these rates to compensate for the risk of providing a loan to a borrower with poor credit. Interest rates range between 10 to 20% for hard money loans.
- Short-term loans: Unlike traditional loans, hard money loans are not useful for long-term financing. While it is very common to have a 20-year mortgage or a 30-year mortgage, this is not the case for hard money loans. Although there is no standard rule as to the term of hard money loans, these loans generally have to be paid back within a few months or a few years. Besides, the longer the term of the loan, the higher the interest.
- High origination fees: As hard money loans are a riskier investment for a private money lender, it is common to see that private lenders generally charge high origination fees to process the loan. For example, if a typical traditional Bank charges 1% of the total loan as their origination fees – it is not surprising to note that hard money lenders charge 5% to 8 % of the total loan.
- Property is the collateral: Unlike a traditional loan where your credit score will act as collateral for your lender, a hard money loan property uses the property as collateral, and thus if you fail to pay back your interest dues and loan payments on time, your lender can take over the property, and you might lose your property. However, this shouldn’t be worrisome if you pay your dues on time.
Benefits of Hard Money Loans
Quick processing of loan: Since you will be working with the individual hard lender or this is a small group of lenders – you can rest assured that the loan processing time would be very less, and you can obtain your loan very quickly.
This is one of the biggest advantages of hard money loans, and you don’t have to keep waiting for a long time to get your loan approved. In some cases, it can be approved within 2 to 3 days.
Higher borrowing limit: In traditional loans, the lender might require you to put down a minimum of 5% of the purchase price as a down payment. In banks, this down payment is even higher, costing around 20% of the purchase price.
If you choose to buy a hard money loan, you might be able to negotiate terms and request your lender to lend you 100% of the purchase price without a single penny of a down payment. Thus, this gives you more room to extend your borrowing limit.
Best when you’re just starting: Lastly, when you are just starting, hard money loans are one of the best options you can choose to purchase property as you are putting in very little of your own money. If you choose your investment wisely and ensure that it is a lucrative one, you can reap high returns from your commercial real estate Investments.