How Does a Hard Money Loan Work?

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What Is a Hard Money Loan?

Real estate investors look for short-term financing they can repay once they flip a property or generate cash flow from rents. They may also need different qualifying criteria than traditional mortgage lenders offer. Hard money loans are a top choice for these investors.

Definition

A hard money loan is funded by private investors and secured by the property it’s financing. Although it’s typically used to purchase real estate, it’s very different from a traditional mortgage loan even though both types use the property as collateral.

Key Characteristics

Hard money loans have unique characteristics that set them apart from traditional mortgage loans.

• High interest rates: As of March 13, the average standard mortgage rate was 6.65%, according to Freddie Mac. In contrast, you’ll pay up to 15% interest on a hard money loan.
• Low loan-to-value ratio: Hard money loans are usually limited to no more than 75% of the property’s value, so you’ll need a substantial down payment.
• Shorter terms: Thirty years is the gold-standard term for residential mortgage loans. Hard money loans are usually repaid over six to 18 months.
• Property value-based eligibility: Hard money lenders look at the property’s value and the borrower’s investment track record when deciding whether to approve an application. With the usual residential mortgage loan, the borrower’s creditworthiness plays a larger role in the lender’s credit decision.

How Do Hard Money Loans Work?

If you’re considering a hard money loan for your real estate investment, understanding how the loan works will make the process more efficient.

Loan Approval Process

Whereas federal law requires traditional mortgage lenders to approve loans based on strict ability-to-repay criteria, hard money lenders have more leeway. Instead of approving borrowers based on their credit qualifications, hard money lenders look at the current property’s value as well as it’s projected worth after repairs have been made.

Credit scores, loan-to-value ratios and debt-to-income ratios have much less of a role in getting a hard money loan approval versus traditional mortgages. Hard money borrowers typically only need to submit basic income documentation.

The flexibility hard money lenders have in evaluating applications makes it possible for them to approve and close on loans much faster than mortgage lenders can — in as little as a few days, in fact, compared to the four to eight weeks traditional lenders need.

Repayment Terms

Hard money loans don’t come cheap. Expect to pay up to 15% interest, plus as much as 4% of the loan amount in lender fees.

Borrowers typically make interest-only payments during the loan term. That makes the loan more affordable while you’re renovating a flip or rental property. It also means you’ll have to make a balloon payment when the loan term ends.

When To Consider a Hard Money Loan

Hard money loans are especially well-suited to particular properties and investors.

Real Estate Investment Opportunities

A hard money loan is best used as short-term financing for real estate investment properties. This kind of financing makes sense for investors who’ll soon generate cash flow from a residential or commercial rental property, or who plan to flip a house.

It’s also a good choice for properties that don’t qualify for conventional or government-backed loans because they’re in rough shape. Hard money lenders look at the property’s after-repair value, so its current condition is less of an issue as long as the investor can convince the lender that the project is viable.

Borrowers With Credit Challenges

Hard money lenders are far more concerned with the value of the collateral and the borrower’s credibility as an investor than they are with the borrower’s credit history.

How do you know if you’ll be approved? Ask yourself if these apply:

• You have a track record of successful real estate investments.
• You can document your project’s value and your ability to complete it.
• You’re on solid financial footing.

If the answer is yes, you have a good chance of being approved.

Advantages of Hard Money Loans

Hard money loans have clear benefits for investors.

Speed and Flexibility

You can have your money in less than a week after being approved for a hard money loan. That could give you a definite edge with sellers anxious to close quickly. Terms are flexible, as well, so you can negotiate a repayment period suitable for your project.

Less Stringent Approval Criteria

The eligibility criteria for hard money loans are less stringent than the criteria for standard mortgage loans, particularly where credit is concerned. You’ll have to prove the value of your project and your ability to deliver it, but as long as your financials are sound, you won’t need good credit to qualify.

Disadvantages of Hard Money Loans

Hard money loans have disadvantages you should be aware of before you consider an investment property that’ll require one.

Higher Costs

Borrowing from a hard money lender could cost you more than twice as much in interest compared to a standard mortgage loan. That’s before you add in 2% to 4% in lender fees, plus the closing costs you pay with any real estate transaction.

Shorter Loan Durations

Shorter terms make hard money loans quite risky because they don’t leave borrowers with much wiggle room if the investment flops. An investor who miscalculates the repair timeline stands to take a serious financial hit if they wind up owning the property longer than anticipated or have a longer vacancy than they’d planned for. The result could be a balloon payment due on a property that hasn’t generated any income.

How To Find a Reputable Hard Money Lender

The lender you choose can have a major impact on the success of your project.

Research and Referrals

Real estate agents with experience in investment properties are a great source of lender recommendations. So are other investors. You can connect with both at investing seminars and by joining an investment club in your area.

Not all states require hard money lenders to be licensed, so it can be difficult to verify a lender’s credentials. However, those who are members of a professional organization like the American Association of Private Lenders must adhere to professional and ethical standards and meet educational requirements for certification by the organization.

Comparing Offers

Once you’ve identified a couple of reputable hard money lenders, ask them for rate quotes and loan details. Comparing rates, terms and fees will help you find the best lender and the best loan for your investment.

Alternatives to Hard Money Loans

If a hard money loan isn’t right for your project, consider the alternatives.

Traditional Bank Loan

A traditional mortgage loan could be a good option for longer-term projects. A residential loan is good for properties with up to four residential units, although some loans require that you live in one of the units. The benefits are a lower rate and lower down payment requirements, but you’ll need stronger credit to qualify.

Private Money Loan

Hard money loans are almost always private money, but private money loans aren’t necessarily for hard money. Hard money loans use the property as collateral, and they often have a more formal approval process that requires a business plan and other documentation related to the investment.

Non-hard-money private lenders, on the other hand, can use whatever lending criteria they want. The lenders might be individual investors — including your family and friends — or investing clubs or other groups looking for deals to finance. While non-hard-money private lenders might have more flexibility than hard-money lenders, you won’t necessarily get the same level of expertise and guidance.

Information is accurate as of March 13, 2025.

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