Why do investors usually favor hard money loans over traditional loans?
The name “hard money” references the loan being collateralized by a “hard asset,” typically real estate but also lends to why an investor would typically choose it over a traditional loan. Meaning the loan you want was “hard” to qualify for in the traditional way! When an investor needs money quickly (within a few days), has a low credit score, or doesn’t have the income or assets to qualify for a traditional loan that usually has more favorable terms and interest rate, investors will turn to hard money loans as a short-term bridge loan to a long-term traditional loan, when they plan to sell the asset soon, or come into funds in the near future to pay back the loan quickly.
What are the downsides of using hard money?
There are several downsides to using hard money loans:
Low loan to value of asset ratio or require a large down payment.
High interest rate (usually double what traditional loan rates are).
Short loan term before you are required to pay the balance back. If you fail to do so, you risk losing the asset that was being used as collateral for the loan.
High closing costs and broker fees. Since you are working with individuals or non-traditional lending institutions that know you are coming to them with an immediate need, you will often see higher fees compared to traditional loan closing costs.
What exit strategies are hard money loans best used for?
Hard money loans should only be considered as “bridge” or short-term loan. The most obvious use is with a real estate flip where you found a good value on a home, intend to quickly renovate it and sell it. You run a tremendous risk if you have material delays, or the home isn’t sold and either must come up with the money before the end of the term or risk losing the property to the lender. Another instance is if you want to subsequently purchase a property and plan on receiving a lump sum of cash in the short term to pay off the loan. Maybe you found a property and you are selling a business or large asset that hasn’t closed yet or you inherited assets and you are waiting for the estate to settle.
Sathya Chey is a registered representative with, and securities and advisory services are offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.
LPL Financial and Arise Private Wealth do not provide real estate services or products.