Hard Money Loans Unveiled for Eager Real Estate Investors

Key Takeaways 

• This loan type, which is secured by property, is mainly used in real estate transactions. 

• Hard money loans are widely considered short-term bridge loans or loans of last resort and are generally issued by individuals or companies rather than banks.

• Hard loan borrowers generally tend to be short-term investors and “flippers” — those who purchase a property, hold onto it for what is usually under a year, renovate it, and then sell it for a higher price.

Real estate investors and those considering entering the market would do well to understand hard money loans, which are chiefly used in real estate transactions but are not offered by banks. With that said, here is an explanation of what hard money loans are, how they work, who they benefit, and more.

What is a Hard Money Loan?

This loan type, which is secured by property, is mainly used in real estate transactions. Hard money loans are widely considered short-term bridge loans or loans of last resort and are generally issued by private individuals or companies rather than traditional banks.

Hard Money Loan: How Does it Work?

The terms of these risky ventures largely hinge on the value of the property put forth as loan collateral. That differs from bank loans, which are primarily based on the borrower’s creditworthiness. Hard money lenders can usually lend up to between 65% and 75% of the property’s existing value, and loan terms are generally between three and 18 months.

Generally, hard money loans have higher interest rates than conventional mortgages, reflecting the relatively heightened risk the lender takes in providing the financing. Rates can even top those of subprime loans. Recent rates on hard money loans averaged between 10 percent and 18 percent, rendering such loans significantly pricier than traditional mortgages, which currently run between four percent and 5 percent.

Working out the interest on a hard money loan calls for taking the loan amount and multiplying it by the proffered interest rate. This means that, if the offer is a $100,000 loan that carries an 8.5 percent interest rate, the overall interest paid would amount to $8,000. Likewise, if the offer is a $300,000 loan with a seven percent interest rate, the overall interest paid would be $21,000.

While hard money borrowers generally are not required to submit the voluminous paperwork that traditional banks usually require, they will have to turn in some documentation that may include:

• Financial documents such as proof of income or personal financial statement
• A personal guarantee
• Assurance of access to enough cash to take care of any and all anticipated property renovations.  

Such documentation will vary and depend on the lender, as well as any prior relationship with the lender.

Why Would You Get a Hard Money Loan?

Hard loan borrowers generally tend to be short-term investors and “flippers” — those who purchase a property, hold onto it for what is usually under a year, renovate it, and then sell it for a higher price. As such, they are generally more apt to accept the higher rates in exchange for expediency, which is the hallmark of such loans.

It is not unusual for borrowers to have funds in hand in around 10 business days. Contrast that with traditional loans, for which the wait time runs between 30-50 days. Borrowers usually plan to repay the loan right away, thus mitigating the higher rate’s impact and making the loan less expensive.  

In addition to turnaround scenarios, hard money loans are also used in short-term financing. They also are common among borrowers who have poor credit but a great deal of equity in their real estate. Because they can be garnered so quickly, such loans can be used to forestall foreclosure.

In addition to quicker access to capital, borrowers can expect less stringent qualification requirements and potential repayment flexibility, although they may be required to submit a higher down payment.

In general, hard money loans may be a better fit for particularly affluent investors who need property funding fast. They are often used to cover a one-time project or expense.

Why Would Someone Lend a Hard Money Loan?

With all the risk involved, it is natural to wonder why an investor or company would ever lend such a loan.

One common reason is that the collateralized property may ultimately be worth the loan amount, if not more, particularly following any renovations. A related reason is that the lender simply believes the property is a worthwhile investment.

Hard Money Loan: Real World Example

To illustrate, a borrower sought to buy a fixer-upper for $100,000, with renovation costs estimated at $30,000. The anticipation was that the rehabbed house could be sold for $180,000. Thus, the hard money lender lent 70 percent of the property’s projected value after renovation.

In another example, the hard money loan was for $250,000 with a 7% interest rate and a six-month project turnaround time.

Net profit = $410,000 – $354,354.65 (repair and flip expenses) = $55,645.35

Loan amount = ($260,000 + $52,500)*0.8

Loan amount = $250,000

Monthly repayment = $250,000*0.07/12

Monthly repayment = $1,458.33

Total interest paid = $1,458.33 over six months

Total interest paid = $8,750

Down payment = Purchase price + Renovation budget – Loan amount

Down payment = $260,000 + $52,500 – $250,000

Down payment = $62,500

The overall renovation and flip expenses are the sum of all anticipated costs associated with the property fix. Here, costs included the loan amount, down payment, property taxes, total interest paid, and state recording and transfer tax. Other expenses included an origination fee, closing costs, title insurance, a realtor fee, property insurance, and overall holding costs.

Ultimately, the total renovation and flip cost came to $354,354.65.

Pros and Cons of a Hard Money Loan

There is no perfect loan product, and that goes for hard money loans. However, there are benefits for the borrower. 

As for the advantages, the loan approval process tends to happen quicker than it would for a traditional bank loan.  Hard money lenders – typically private investors – can decide on applications faster since the lender’s focus is the collateral instead of the borrower’s credit and finances.

Compared to bank loans, hard loan lenders tend to spend less time going through an application reviewing financial documents and verifying earnings or other income, for instance. 

As for the investors, they are not as worried about repayment since they have the borrower’s collateral, which may be worth more than the loan.

There are potential drawbacks to hard loans, including what are usually higher loan-to-value (LTV) ratios than conventional loans. The LTV ratio is an evaluation of lending risk that banks and other lenders study before green-lighting a mortgage. Usually, loans that show high LTV ratios are deemed higher risk, which often results in a higher interest rate. For most lenders, 80 percent is the threshold for a favorable loan-to-value ratio.

Further, loans with a high LTV might call for the borrower to buy private mortgage insurance (PMI) to offset lender risk.

Other potential drawbacks include interest rates that tend to be high, as well as the possibility that lenders may not wish to offer financing for a residence that is occupied by the owner, due to compliance rules and regulatory oversight.  

Investing in Real Estate

While no investment is risk-free, real estate remains a popular investment, its benefits including possible steady secondary income streams, leverage, cash flow, and tax favorability. 

Investors and those seeking to enter the real estate market might want to consider Yieldstreet’s offerings. The leading platform for “alternative” investments – those other than stocks and bonds – Yieldstreet has more asset classes than anyone else. To date, nearly $4 billion has been invested on the platform.

Among Yieldstreet’s offerings are those in real estate – private as well as commercial, including a real estate investment trust (REIT).  With the company’s Growth & Income REIT, investors can take a position in real estate sans physical property possession. In general, such trusts are enterprises that own commercial properties including hotels, office buildings, retail spaces, and apartment buildings.

At Yieldstreet, the real estate trust puts equity in commercial real estate of varying types – industrial, multi-family, self-storage, and retail — in key markets nationwide, with minimums as low as $10,000.

There is another major benefit to investing in real estate: portfolio diversification. Spreading investments within and among disparate asset types can shield against inflation and stock market volatility and is foundational to successful investing.  

Alternative Investments and Portfolio Diversification

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

Despite their shortcomings, there are definite benefits to hard money loans for investors, developers, and those known as property “flippers.” Loan terms are generally short and can be arranged much more swiftly than a loan through a traditional bank.