Hard Money Loan - What are the Advantages and Disadvantages?

6 Replies

I am looking for an investment property and the local real estate group that I've networking with often suggest using a Hard money loan.  Can someone explain to me how that really works?  I've heard that they can be up 12% sometimes?  If I got this route should I look for both the Hard Money lender and the Conventional Lender before I buy?

did you try searching on the site? there are only 25,000 mentions of hard money and how it works.

Better used on flips vs. buy and hold.  Typically it's a short term loan (eg 6 months - 1 yr) at a high interest rate (eg up to 18%) where you pay interest only payments.  Often require a down payment (eg 20%) to ensure you have skin in the game.  Of course there are many variations so call around in your area.

There are also soft money loans geared toward buy and hold with longer terms, but I'm not very familiar with them.  

Thanks Mike.   I'm actually interested in buy and hold so maybe I'll research soft money loans too.  Are they different than conventional loans?

Hi Nature: There probably are 25,000 posts about hard money but I'll try and save you some time.  Which, by the way, is one reason to use hard money. 

Hard money is a quick way to get financing that you might otherwise not have access to.  A good hard money lender should be able to make a decision in days instead of weeks and sometimes months like a traditional lender would take.  

A hard money lender will care more about the project than they will the borrower.  When I'm looking at a deal, I care mostly about the collateral that I may have to take back if the borrower doesn't perform.  For people just starting in the real estate biz or those who don't have great credit,  this is a big plus.  You do however have to have the skills to find a good deal and present it in a half way coherent way.   

While hard money will cost more ( usually a certain amount of " points " up front and a higher monthly interest, it is also a valuable tool.  A good partner will not just help you with the money but they will have done lots of deals.  They'll have contacts for contractors, title companies, and pretty much everything else you'll need in the real estate world.  They should be a great resource for you to ask advice when you get stuck on something.  Remember, their money is at risk so they will want to protect it.  

While hard money may cost more than a bank, it's just another cost of the transaction.  Develop a relationship with a money partner and build their cost in to the deal.  A good partner will bring fast money and value to your deals.  Most likely deals you wouldn't have without them.

Originally posted by @Nature B.:

Thanks Mike.   I'm actually interested in buy and hold so maybe I'll research soft money loans too.  Are they different than conventional loans?

 A quick note on soft money;  if I'm looking at a deal which involves a long term hold, I will usually want equity and a believable plan on how my money is getting returned.   

If you're not seasoned in real estate, it's going to be a long hard process for you to go to a bank and get started with a fix and hold today.  You can do it, but make sure you have a good loan officer who will hold your hand.  Also make sure you know what you're plan is going to be and understand your debt to income ratios.  You could end up with a cash flow negative property pretty quickly.  

Here is an outline of some of the differences between buying with a hard money loan and a conventional loan -along with some of the pros and cons:

1) CONVENTIONAL LOAN

a) Down payment: 25 to 30% on Investment Properties
b) Rehab costs: All rehab costs are paid out of pocket by the buyer
c) Points/Closing costs: No points (or maybe .5 or 1% or something really low) to close
d) Rates: Better rates 4.5 to 5.25%
e) Amort length: Longer amortization period (30 yr mortgages) to help cash flow
f) Paperwork: Qualifying is much more time consuming
g) Refi needed to get investment back out: Need to do a cash out refi in order to get any of the down payment or rehabe money back. Cash out refi's are NOT very easy to do these days on investment property.

2) HARD MONEY LOAN

a) Down payment: 0 to 10%
b) Rehab costs: Rehab costs can be rolled into the loan
c) Points/Closing costs: 5 to 6 points (percent) of the loan - some are more or less
d) Rates: Much higher rates 10 to 14%
e) Amort length: Interest only loans - nothing comes off the principal
f) Paperwork: Much more straightforward. Much less nonsense.
g) Refi needed to get investment back out: Rate and term refi.

For a flip, you have to have a great deal to make the numbers work. The points and interest rate are going to eat up a good size chunk of the profits. So there has to be pleny of room in the deal to make hard money work for a flip.

Buy a hold, on the other hand, is where I believe hard money really brings the most benefit. By rolling in your purchase and rehab costs into the loan, you can get into a deal with little to no money down. In addition, you can then rate/term refi them into a conventional/portfolio loan as soon as the house is rehabbed/rented (well there are some limitations to that though).

But this essentially means you can add a house that needs repairs for 5 to 10% down and with the rehab costs included. This allows you to grow much faster with as little out of pocket expense as possible.

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