Whether you’re a seasoned investor or new to real estate investing, you’re sure to hear about hard money loans at some point in your investment journey. Hard money loans offer an easier way to borrow money for some investment property purchases. 

Of course, there are also some significant downsides to hard money loans that you need to consider with care. Read on for a deeper look at how hard money loans work, along with the pros and cons you’re likely to encounter with this type of investment property loan. 

What Is a Hard Money Loan?

A hard money loan is a type of non-conforming real estate financing offered by a private, nontraditional lender. These short-term investment loans usually feature expedited repayment terms and high-interest rates. 

There is, of course, a trade-off for these less attractive loan terms. With hard money lending, the approval criteria you’ll need to satisfy can be a lot more lenient. Funding times on hard money loans are much faster compared to traditional investment property loans.

When you take out a mortgage, you usually have a month or more between the time the seller accepts your offer and the date of your loan closing. It’s not unusual for hard money loans, by comparison, to close and fund within a few business days. 

Hard money loans get their name from the asset that you use to back the loan — aka the property you purchase. If you fail to repay a hard money loan as promised, the lender can take possession of the property and sell it to a third party to recuperate its investment. 

How Does a Hard Money Loan Work?

With a private lender, the value of the property you wish to purchase is the most important detail on your loan application. You might qualify for some hard money loans with a bad credit score. But if the loan-to-value ratio is too high, you’re likely to receive a loan denial. 

Loan underwriting can be faster and less stressful with a hard money loan too. You might not have to supply as much documentation as you would with a traditional bank loan. For example, you might qualify without providing bank statements, tax returns, and more. 

Once an acceptable appraisal comes back, the final loan approval can move at a faster pace. 

But since the lender is accepting more risk with a hard money loan, you can expect to pay more —sometimes a lot more— for this type of real estate financing. 

Drawbacks of Hard Money Loans

It’s important to consider the risks and the drawbacks whenever you take out any new loan. And there are some significant disadvantages to think through before you move forward with hard money financing. 

Cost

One of the biggest reasons to pause before taking out a hard money loan is the cost. Every private lender is different. But it’s not unusual to see double-digit interest rates with this type of loan—perhaps 10 or more percentage points higher than you see with a conventional lender.

The average interest rate on a 30-year, fixed conventional loan is 3.12% in December 2021 according to Freddie Mac. Meanwhile, Rocket Mortgage says hard money loan rates commonly climb into the 8%–15% range. 

On top of high APRs, you may have to pay extra fees to the lender. Hard money loans could feature higher closing costs, origination fees, loan-servicing fees, and prepayment penalties. Some private loans may feature a balloon payment requirement at the end of the loan term.

Shorter Repayment Period

You usually have to repay the lender much faster with a hard money loan than you would with a traditional mortgage loan. This type of short-term loan might require repayment in just a few months.

Unregulated

A private investor, like a hard money lender, isn’t regulated by the Federal Reserve like banks, credit unions, and other lenders. With private money, you may not have the same consumer protections a traditional lender has to offer when you borrow money.

Of course, you could face this same drawback with other types of investment loans. Business loans and business credit cards, for example, don’t enjoy consumer protections either.

Benefits of Hard Money Loans

Despite the drawbacks listed above, you might want to consider a hard money loan under the right circumstances. If you’re comfortable with the risk, below are three benefits that working with a hard money lender could offer you. 

Convenience

Getting a hard money loan can be more convenient than a traditional mortgage or real estate investment loan. There are several reasons why this is true.

• Funding speed with private loans could be a matter of days, not weeks or months. 
• Usually these loans are used for making substantial renovations, so the property won’t have to be livable to qualify for financing.
• The lender might not make you prove where the money is coming from for closing costs or a down payment. 

Flexible Approval Terms

Hard money loans are primarily collateral-based. The value of the property matters most. If the investment makes sense from a loan-to-value (LTV) perspective, a private lender might approve your application even with credit problems, income challenges, or asset limitations. 

Private lenders still have some minimum hard money loan requirements that you have to satisfy for loan approval. Yet even in this scenario, the minimum credit score the lender accepts will probably be lower than you would encounter with a traditional loan. 

Collateral

Like most real estate loans, the property itself acts as collateral with a hard money loan. So, you probably won’t need to pledge additional assets to a private lender to secure financing.

If you default on a hard money loan, the lender can take possession of the property. This arrangement reduces the lender’s risk and ensures it has something of value to resell if it needs an alternative way to recover its investment. 

What Is the Down Payment Requirement for a Hard Money Loan? 

The down payment size a hard money lender requires from you can vary based on several factors. The loan amount, loan-to-value ratio, and other details can all have an impact here. 

In the best-case scenario, you might be able to get a private money loan with no money down. That can be an attractive feature for an investor who needs a flip loan for a quick resell. 

Yet in many hard money scenarios, you’ll need a big down payment instead of a small one. Some lenders may only be willing to finance 70% to 80% of the value of the property. It’s not unheard of for a hard money lender to want a borrower to put 30% or more down. 

When Should You Consider Working with a Hard Money Lender? 

Hard money loans tend to work best for fix and flip scenarios.

Taking out a hard money loan isn’t the right move for every real estate investor, nor every real estate transaction. If you’re not confident that you can rehabilitate and resell the property in a timely manner, the risks involved with a hard money flip loan are probably too high. 

In some situations, however, a private money loan could pay off and help you finance a profitable investment deal. Below are a few examples: 

• Hard money loans can be easier to get. They may work for investors that need financing and don’t have big lines of credit.
  
• They can give you a competitive edge. In a hot real estate market where you’re facing a lot of competition, the promise of fast money could help your purchase offer stand out compared to other interested buyers.
  
• You plan to resell the property quickly. If you’re buying a home to fix and flip, you might not need a loan that offers lengthy repayment terms. 

If you decide to move forward with a hard money lending scenario, take the time to shop around for the best hard money lender. When you compare multiple loan options, you can make sure you find the best deal available for your situation. 

In the long run, it’s wise to work to put yourself in a position to qualify for more affordable financing options. Working to build personal credit and business credit could help you. 

Note that your business credit scores and personal credit scores are separate. But depending on the type of financing you apply for, either or both of them might impact your approval odds. 

If you need to establish credit, a credit builder loan may be worth considering. Credit Strong offers credit builder loans for both individuals and small businesses, offering you the opportunity to build positive credit history with the consumer and business credit bureaus. 

FAQs

Do Hard Money Loans Require a Down Payment? 

The private money lender you work with and the loan details determine whether you have to supply a down payment with a hard money loan. No money-down loans are possible. But you could also face down payment requirements as high as 30% or more in some situations. 

Does a Hard Money Loan Appear on Your Credit Report? 

For a hard money loan to appear on a credit report, the lender must sign up to be a data furnisher with at least one credit reporting agency. Being a data furnisher is an involved (often expensive) process. So, most hard money lenders don’t share data with the credit bureaus. 

Before you apply for a loan, you can ask the lender if it reports account information to the business or consumer credit bureaus. Asking this question is the most reliable way to find out if a private money loan will show up on your credit report after closing. 

Do You Have to Make Monthly Payments on Hard Money Loans? 

Most hard money lenders will require you to make some sort of monthly payment on the loan. In some cases, however, the lender may set up an interest-only repayment schedule to help make up for the high-interest fees it charges. 

If you sell the property quickly, there might be a scenario where you never have to make a payment on a hard money loan. But that’s also true of any loan you pay off before the first payment is due. Watch out for prepayment penalties if a quick payoff scenario interests you. 

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