When you think of investing in real estate, be it residential properties or commercial properties, you have to explore the various commercial real estate financing opportunities. There are multiple ways through which you can fund your commercial real estate investments and knowing these ways will suit these property financing situations.
It is very crucial – as lending is a significant part of the real estate game. While talking about the availability of types of loans, you should know that there are two major types of loans – Bank loans and Non-bank loans.
Bank loans are the loans provided by the banks or other traditional lending institutions which have a strict set of lending policies and tough documentation for loan eligibility.
On the other hand, non-bank loans are the loans that are funded by sources that are not banks or financial institutions. You can expect these loans much lesser stringent policies and flexible loan eligibility requirements.
This blog is an overview of Hard Money Loans which is one of the most common types of non-bank loan. We will cover everything about these loans from how they came into existence, different types of hard money loans and different case scenarios explaining how these loans are the perfect fit for you.
Where did Hard Money Loans come into existence? A little backstory –
Hard money loans had existed in the market even before the term ‘Market’ was coined. In the early days, hard money loans refereed to a hand loan provided by the lender to a borrower, without any collateral, purely based on trust and the credibility of the borrower.
So what was the security then to the lender you may wonder? Well, in early days, lenders resorted to violent ways to recover their debts from the borrowers, and that’s how the term ‘Shark Lenders’ was introduced.
These lenders would lend any amount of money to someone who need money without any collateral security. But if in the event of defaulting repayment of the loan, these lenders would threaten to kill the borrower.
It was how the lending business first started and ever since then, the scope of lending and borrowing has changed along with the advent of technology and the growing civilizations and economies all over the world. Over the years, the way “Hard money Loans” are perceived has changed so much.
What are Hard Money Loans in today’s context?
In today’s world, a hard money loan means non-bank loans. In other words, loans provided by private money lenders which includes an individual, an agency, REITs, trusts, corporations, etc.
Loans from these lenders is referred to as hard money loans where there is no intervention of banks or other traditional lending institutions. Thus, the loan eligibility requirements for a hard money loan is not as stringent. Instead of funding the loan solely based on trust and the credibility of the borrower, today, hard money lenders dallas tx require the borrowers to provide the real estate property as collateral security.
So, in an event where the borrower defaults in repaying the loan principal or the interest, the lender will use the collateral property to recover all his dues.
Bottom-line: Hard money loans are non-bank loans provided by lenders who require real estate property as collateral security.
However, the terms of hard money loans are much shorter and the interests much higher than that of a typical regular loan taken from a bank. Read on to understand the most common types of Hard Money Loans and find out the answers to the most frequently asked question about hard money loans.
What are the most common types of hard money loans?
1) Mortgage refinancing hard money loans
Mortgage refinancing is the first type of hard money loans. Mortgage refinancing refers to a funding arrangement where a borrower buys a new loan to pay off the existing loan which is taken towards purchasing a commercial real estate property.
The new loan taken would clear off the old loan along with all the loan liabilities attached and provide the borrower leverage of more time to pay off this new loan taken.
Mortgage refinancing is not a concept that is encouraged by the banks since it is a loan made to clear off another loan. That is where private loan lenders come into the picture.
These lenders provide hard money loans to homeowners or commercial property investors who can use this loan to get rid of their existing loan liabilities.
Best-case scenarios where refinancing makes sense:
#1 – To secure a loan with a lower rate of interest.
One of the best reasons for refinancing is when you wish to lower the interest rate of your existing loan. With newer loans coming up in the market, you may find a loan which has a lower rate of interest to offer than your existing loan. In such cases, refinancing your existing loan with the new loan is an excellent idea. It will significantly lower your monthly payouts towards clearing off your loan liabilities. As a general rule, experts believe that an interest rate decrease of 2% is a good reason why you should consider refinancing. However, many real estate investors believe that a reduction of 1% interest rate too is an excellent reason to refinance.
#2 – To shorten the term of the loan
Next good idea or a case scenario is refinancing your old loan when you find a loan that has a similar rate of interest to your existing loan. Reducing the duration of your loan not only lower your overall interest payouts but also increases the rate at which you will acquire more equity in your property.
#3 – To convert an Adjustable Rate Mortgage into a Fixed Mortgage and vice versa
Adjustable Rate Mortgages or ARMs generally start out by providing lower rates than the fixed-rate mortgages, but as time goes by, there are chances that the rates of such loans shoot up and eventually get higher than the fixed-rate mortgage spread throughout. In such a case, it’s best to switch and refinance your ARM to a fixed mortgage. On the other hand, if you have a fixed-rate mortgage and there are attractive ARMs available with a steady lower rate of interest, converting your fixed mortgage into an ARM can save you a great deal of money.
2) Bridge loans
The second type of hard money loans is bridge loans. Commercial real estate bridge loan lenders are loans that are taken to bridge the financial gap and provide immediate financing until a more permanent type of investment is made available.
The best example to understand how bridge loans are when you want to invest in a new property before the sale of your old property is completed.
In such a case, sourcing a bridge loan is the best strategy as you’ll be able to buy your new property with the bridge loan proceeds and you can later pay off this loan after the sale of your old property is completed.
Best-case scenarios where bridge loans make sense:
#1 – When you want to buy a new property before the sale proceeds of an old property is realized
As explained in the above example, this is the most typical case scenario, where choosing to finance a bridge loan makes the most sense.
#2 – When you need working capital to keep your business afloat until you realize the proceeds of a new deal that’s coming your way
It’s widespread for companies to run out of money that’s needed to run the day to day operations of the business. In cases where a business is counting on a big project that’s coming its way in a couple of months, the business might want to source a bridge loan to fund its working capital requirements needed to keep the business afloat till this deal comes.
#3 – When you wish to relocate your place of business operation
Relocating your place of business operation will require to invest in the new property when your old business is still running in the old place. At such cases too, you can source a bridge loan through which you can purchase, lease or rent out new space and wait until you sell off your old business place or figure out another exit strategy to do the same.
#4 – When you want capital to make repairs and renovations to your property
Making repairs and renovations to your building can increase your income earnings by way of attracting newer and better clients. In such cases, you can choose to raise a bridge loan which will help you take care of the repairs and renovations. This bridge loan can be paid off later using the revenue generated as a result of your renovations.
3) Home equity loans
Home equity loans are the third common types of hard money loans. A home equity loan is a second mortgage on your home, over and above the first mortgage that you took to purchase your home. Home equity loans are the loans that you can source on the basis of the equity you own in your home or the equity value you have in your home over the outstanding mortgages attached to your home. For instance: If the value of your home is $100,000 and the outstanding first mortgage on your home is $70,000, then you are eligible to get a home equity loan by providing the $30,000 equity that you have in your home as collateral.
Are hard money loans for bad credit?
Hard money loans are provided on the basis of collateral you provide which is generally the real estate property you are planning to purchase itself and thus, hard money lenders do not care much about your credit score. So if you’re struggling with bad credit, hard money loans are definitely for you.
