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How Does a Hard Money Loan Work?

Hard money loans are a quick, easy way to raise capital when looking to invest in a property. Unlike other loans, which take your financial trustworthiness into account, hard money – or private loans- rely on property collateral, rather than creditworthiness. Hard money loans are great ways to free up cash flow for investment properties or flipping houses, and allow the borrower to allocate the money how they see fit. Hard money loans are not lent through banks, so borrowers rely on individuals and companies to lend money for their investment. Learning more about the process of hard money loans is a great way to start if you are looking for a quick and easy way to free capital for other real estate investments.

How to Apply for a Hard Money Loan

Hard money loans are different from most other forms of loans. They rely on the borrower’s property as collateral, thus minimizing the need for a lengthy borrowing process. However, it is important to know a few things investors look for when a person applies for a hard money loan.

  • Collateral: This is what the borrower issues to the lender as a form of security. For hard money loans, this comes in the form of real estate. This way, if the borrower defaults on the loan, the investor can resell the property, minimizing their risk.
  • Loan-to-Value Ratio: This is the assessment investors make of their potential lending risk. The LTV is determined by the mortgage amount divided by the appraised property value. For hard money loans, most investors cap at about 65% or less (for example, if you have a $500k home, an LTV of 50% would be $250,000).
  • Credit Score: Although less important, in hard money lending where the property is collateral, investors may look at credit scores when determining whether to invest. This shows how likely the borrower is to pay back in a timely manner.

When looking to apply for a hard money loan, these factors are important to consider, along with certain information that is included in the application process. This may include the type of property, the purchase price, the purpose of the loan, and the construction budget for your investment property. Keep these factors in mind will have you prepared to apply for a hard money loan.

How to Get Approved for a Hard Money Loan

The main factor to consider in getting approval for a hard money loan is the down payment on a property which is then used as the collateral for the loan. The minimum down payment amount shifts depending on the type of property. For commercial properties, the down payment ranges from 30-40%, whereas residential properties are lower at 25-30%. Borrowers are more likely to receive the loan when there is a higher down payment. In certain circumstances, investors may offer a “cross-collateralizing” deal where multiple properties are used as collateral to gain a loan.

Other factors to consider may include cash reserves for holding costs and the monthly loan payments. The higher the amount of cash reserves, the easier it is to get the loan. Another factor may simply be experience in real estate. Although not impossible without experience, a borrower can expect to have a more detailed plan for the project to present to potential investors with information such as an exit strategy.

How to Use a Hard Money Loan

Hard money loans are great for people looking to invest in real estate as they provide capital in a quick manner. Hard money loans are often put toward buying investment properties, rehab cost of the property, and any supplies needed for the renovation. This is great for borrowers who are looking to invest quickly and profit from their properties, as it frees cash flow in order to contribute to other investment ventures.

When thinking about the purpose for a hard money loan, you could benefit if looking to invest in the real-estate market where there may be competing bids. For those starting out in real estate, both the ability to acquire the loan without previous experience, and the ability to invest as you see fit, are both major ways to use a hard money loan.

Loan Repayment

Hard money loans are great for real estate investors as they enable a quick free up of cash flow, normally a few days after loan application compared to the 30-40 days of a traditional bank loan. However, it is important to keep in mind loan repayment as interest rates are normally higher due to the riskier nature of these loans for investors. As hard money loans are great for short-term investments that can quickly renovate and flip a property, hard money loans are normally paid back within the first six months.

For new real estate investors, it is imperative to think about exit strategies. This is crucial in the case that a property investment does not go as planned. A few things to consider in exit strategies include looking at the property sale history, potential future buyers, and the financials of the property. Having an actionable objective as to how you want to utilize your hard money loan, and how it is going to help the property, is critical in the repayment process.

Hard money loans are great for those who are looking to free cash to invest in the real estate market. By having a plan to utilize the loan to your advantage, is a great way to begin investing. For those looking to quickly raise capital, understanding the functionality of hard money loans can increase success in enhancing your portfolio. Let us help you today!

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