What Is Hard Money?

A common question for many looking into real estate is, “what is hard money?” The definition of hard money is any money that’s backed up by a physical asset, such as gold or silver. Hard money loans are a type of loan that’s backed up by real property. Because this money is backed up by a physical asset, it’s thought to retain its value better than soft money.

There are numerous benefits to choosing a hard money loan over a traditional loan, including faster loan processing and less scrutiny of your credit score and debt-to-income ratio. However, it’s important to understand what you’re getting into before you secure a hard money loan. If you’re considering a hard money loan, here’s a quick guide to hard money loans and what you need to know before you secure one.

What Is a Hard Money Loan?

Hard money loans are loans that are backed up by some sort of physical property. These are typically short-term loans that come with different terms than traditional loans, which may make them a better option for some borrowers. If you have a difficult time securing a traditional mortgage loan, you may be able to opt for a hard money loan instead that’s issued by a lender in real estate. In many cases, hard money loans are used to secure the funding needed to invest in houses for house flipping.

Hard Money Loans vs. Traditional Loans

There are several key differences between hard money loans and traditional loans. While many people use hard money loans because they’re not able to qualify for a traditional loan, there are certain benefits that may make hard money loans a better option for some. Here’s a comparison of hard money loans and traditional loans.

With a traditional loan, lenders look at your credit score as well as your debt-to-income ratio to decide whether or not to offer you a loan. If your credit score isn’t great or your debt-to-income ratio doesn’t look right on paper, there’s a chance you might not be able to qualify for a loan. That being said, traditional mortgage loans offer low interest rates and favorable repayment terms, so they can be a good option if you qualify. These loans are typically paid off over a 30-year period.

Hard money loans are a little different because lenders don’t focus on your credit score and debt-to-income ratio as much. This means that individuals who can’t qualify for a traditional mortgage may be able to qualify for a hard money loan instead. Unlike traditional mortgage loans, hard-money loans are repaid over a shorter time period that may be between 6 and 18 months. 

Whereas traditional loans focus on debt-to-income ratio to determine your eligibility, hard money lenders look at the loan-to-value ratio (LTV), which determines the value of your asset compared to your loan. For example, if you’re flipping a home and need a $50,000 loan and the appraised value of the home after it’s repaired is $100,000, the LTV ratio is 50%. This shows that if you default on your loan, the hard money lender can sell the property to repay the loan.

What Is a Hard Money Lender?

When you’re applying for a mortgage loan, you’ll typically be working with a bank or a mortgage lending company. Because mortgages come from licensed lenders, you have to meet certain criteria in order to qualify for a mortgage. This generally includes falling into a particular range in terms of credit score and debt-to-income ratio. Your financial standing may also have an impact on the quality of loans you’re able to secure.

While hard money lenders need to be licensed in most cases as well, hard money loans are issued by private lenders rather than corporations. These private lenders may not put as much stock in your credit score or your debt-to-income ratio, which can make it easier to secure a loan. Because hard money loans are often used for flipping houses, hard money lenders may be more understanding of the varying financial circumstances of real estate investors.

There are some things to consider before you apply for a hard money loan, but it may be a good option if you’ve had difficulty securing a traditional loan.

What Are Hard Money Loans Used For?

In most cases, hard money loans are used as a replacement for traditional mortgage loans, but it’s more complicated than that. Many people who use hard money loans use them as a way to secure funding to flip homes. While mortgages aren’t especially difficult to secure when you’re buying your first home or buying a home to live in, that can all change if you’re investing in real estate.

Residential hard money loans are a common way for people to invest in real estate after they’ve tested the waters. If you’re having trouble getting a mortgage because you recently flipped a home, you may be able to get a hard money loan instead.

Another thing to consider about hard money loans is that they come with different terms than traditional mortgages. Mortgages are typically spread out over a 30-year period and require a certain downpayment, while hard money loans may offer more flexible terms. Because of this, hard money loans can also be a good option if the terms of a mortgage don’t work for you.

Pros and Cons of Hard Money Loans

So, what is hard money good for? It may be difficult to understand when these loans would be preferable to a mortgage, which gives you plenty of time to pay off your loan with low interest rates. Here’s a complete breakdown of some of the pros and cons of hard money loans to help you decide whether a hard money loan or mortgage is right for you.

Pros of Hard Money Loans

  • Fast closing times: Quicker closing times are one of the biggest benefits of hard money loans. While it may not be a big deal if you’re simply buying your first home, the lengthy process of securing a mortgage can make it a difficult option for real estate investors. Hard money loans offer much quicker closing times, so you can move on to your next investment as soon as possible and maximize your bottom line.
  • Flexible terms: Unlike traditional mortgages, hard money loans also offer very flexible terms. The terms of these loans are determined on a case-by-case basis, which means there’s no one-size-fits-all solution. You can customize hard money loans to make sure they fit your needs, while mortgages are a bit more cut and dried.
  • Easier borrowing: When you apply for a traditional mortgage, you have to pre-qualify for a loan before you can even start shopping for a home. The amount you pre-qualify for determines how much you’re able to spend on a home. With hard money loans, you can get a loan for the amount you need based on the value of the property you’re investing in. If you’re borrowing against your own property, your property value will determine how much money you’re able to borrow.
  • Easier to secure: Securing a hard money loan may be easier for some investors. Securing a traditional loan requires a certain credit score and debt-to-income ratio, but hard money lenders don’t put as much stock in these numbers. If you’re having a difficult time securing a mortgage, hard money loans may be a suitable alternative.

Cons of Hard Money Loans

While there are a lot of upsides to hard money loans,  there are also some drawbacks to consider before you take out a loan. Weighing the pros and cons is an important step in deciding what type of loan is best for your financial situation.

  • High interest rates: Traditional mortgages generally come with very low interest rates, which is one of the biggest benefits of securing a traditional loan. Hard money loans, on the other hand, have high interest rates that make them a less desirable option for some investors.
  • Larger down payment: If you’ve had a tough time getting money together for a down payment on a house, that’s not going to get any better with hard money loans. Mortgages offer options for people who can only make a down payment for a small percentage of a home’s value, but hard money loans typically require a larger down payment that may be as high as 30%. Because of this, hard money loans aren’t always an option.
  • Short repayment period: Because hard money lenders want to make money from the loans they’re providing, they don’t typically offer long-term loans. The value of a property can change too much over a 30-year period, and private investors simply aren’t willing to take on that risk in many instances. With a mortgage, you can spread payments out over a 30-year period to make buying a house more affordable.

The Bottom Line: What Is Hard Money?

While a traditional mortgage is a good idea if you’re buying your first home or buying a home to live in, hard money loans may be a better option for real estate investors. Hard money loans offer quicker closing times and more flexible terms as long as you can afford higher interest rates and larger down payments. It’s important to weigh the pros and cons before making a decision.

At Source Capital, we understand that everyone has different needs when it comes to loans. We work hard to offer a wide range of loan options, so you don’t have to work with another private investment firm. Get in touch with Source Capital to learn more about our equity and direct lending solutions.

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