House flipping accounted for 7,5 percent of all home sales across the U.S. in the second quarter of this year – and most of these sales were financed by hard money loans. Whether you’re looking to sell a home in the near future or purchase a property that needs some serious TLC, hard money rehab loans can come in handy when you’re looking to secure a decent return on your investment.
However, there’s a catch.
Hard money loans are not always a good choice for everybody. Yes, they offer a good amount of capital upfront to help you get the jump start you need on your residential rehab project, but there are pros and cons you should be aware of.
Check out the rest of this blog for more.
What Is A Hard Money Loan?
Many people who haven’t done sufficient homework on hard money loans assume they’re the quick fix they need when they’re in a financial pinch. But in reality, there are long-term consequences if you fail to manage the loan and your finances in a smart way.
A hard money loan is a short-term loan where the borrower (you) uses a hard, tangible asset, such as your home, as collateral to secure the loan. They are also called bridge loans, used to finance one home while preparing to sell another.
The Hard Money Rehab Loan
Hard money rehab loans fall under the umbrella of hard money loans and are primarily used to financially support the renovation or rehabilitation of a property. It’s a speedy financial option if you need to fix up or flip a property to sell it and make a decent return on your investment.
How Do Hard Money Loans Work?
In most cases, the value of your loan is based on the value of the property you’re purchasing. Here are some of the key concepts to understand about hard money loans:
- Traditional lenders, i.e. banks, don’t issue these types of loans. You can secure a hard money loan through private companies or individual investors
- The lender will check your credit score and finances, however, this process is far less rigorous than with traditional loans
- This less stringent process means you can be approved for your loan in a matter of days, sometimes even on the same day
- Hard money loans tend to have higher interest rates and might require large downpayments
- They also tend to have shorter repayment periods, most of the time just a few years (3-5 years, on average)
If you ever default on your loan repayments, the lender can take ownership of the asset (i.e. your home) and recoup their financial losses.
What Are Hard Money Loans Most Commonly Used For?
So, what are the most common reasons why people choose a hard money loan? Are they only used for rehab project financing? Let’s take a closer look:
House Flipping/Rehabilitation
If you’re on the hunt for fast property funding if you plan on rehabing or flipping a home, this is a common go-to. Hard money rehab loans are very popular among real estate investors who buy fixer-upper homes and need rehab project financing in order to sell them for a profit.
House flipping is a fast-paced industry. The projects tend to move quickly, hence the reason why investors prefer quick financing in the form of hard money loans. The repayment terms on these loans are short- some as short as a year. This tends to fit in well with the period it takes to flip a home and sell it – another reason why hard money rehab loans are the preferred choice.
Investment Property
If you’re looking to expand your real estate investments and purchase a property, but don’t quite have the funds or qualify for a traditional mortgage/financing, this is where a hard money loan comes in.
These types of loans require far less credentialing and are typically much faster to acquire thanks to a simplified approval process. If you can’t qualify for a loan due to your credit score/history, a hard money loan is a smart way around that.
Commercial Property
Purchasing commercial real estate is often an expensive endeavor, but one that can be very lucrative in the long run. If you’re a business owner looking to expand your business by purchasing commercial property, a hard money loan is a good choice.
You might need quick loan approvals as commercial real estate is a cut-throat industry and properties tend to move off the market fast. A hard money loan is a good way to secure your investment if you can’t quite qualify for a traditional loan or commercial mortgage.
What to Know About Interest Rates, Pros, and Cons
You might have gathered by now that while applying for a hard money loan is a quick and simple process, it’s a risky financial move. This is because hard money loans are expensive thanks to high interest rates. In some cases, they might also require large down payments, too.
A simple example to illustrate this point is that a traditional mortgage with a fixed interest rate sits at an average of 7 percent. A hard money loan has a much higher interest rate, averaging between 8-15 percent.
In some instances, a lender might only agree to finance 70-80 percent of a property’s value. This means you’ll have to come up with the remaining percentage amount, which makes for a sizeable down payment.
Here’s what to know about the pros and cons of hard money loans:
The Pros
- A quick and relatively simple approval process
- You have access to flexible loan terms
- The underwriting process is far less stringent
- You can fix and flip properties quickly, and make a good profit
The Cons
- Much higher interest rates versus traditional loans
- You might have to pay a large down payment, upfront, as well as closing costs
- Shorter repayment terms mean a shorter amount of time to pay off the loan
- There are payment penalties if you default on repayments
Perhaps the biggest drawback of them all is that the lender has the right to acquire your property which you have used as collateral. If you default on your loan, you risk losing your property so that the lender can offset their financial losses.
This is why it’s super important to do your homework on hard money loans beforehand and decide whether it’s something you can manage, and manage well.
Broaden Your Financial and Business Acumen
If making strong, well-measured financial decisions is not your strong suit, then this is your sign to broaden your financial knowledge. Hard money rehab loans are fast and convenient for a reason. They offer almost instant financial relief (in the short term), but they’re not always the best choice, in the long term.
If you’re interested in strengthening your financial and business acumen to help you make better decisions in the future, take some to explore this blog for all the advice you need.
