There are many different types of real estate loans to choose from. The funding method you choose will depend on your specific needs and goals. Each loan type has its upsides and downsides. Real estate investing is much different than purchasing a home that you’ll live in full-time.
Since real estate investors often need to move quickly on an investment property, they’ll forgo a traditional loan and reach out to hard money lenders or other short-term loan providers instead. Investors need to be able to have the cash they need to close on a deal before the property is taken off of the market by someone else.
What Is Hard Money Lending for Real Estate?
Hard money lending is an alternative option to working with traditional lenders. Real estate investors often prefer this lending option because the approval process can be expedited. Hard money lending is used by investors and house flippers and cannot be used by home buyers searching for their primary home.
What Is a Hard Money Loan?
A hard money loan is a faster alternative to a traditional mortgage. Only private or non-traditional lenders offer hard money loans, requiring the borrower to put up an asset they can hold as collateral. The collateral serves as protection for the lender since they work independently.
Advantages of Hard Money Loans
There are plenty of upsides to hard money loans, especially if you’re an investor looking to move fast and avoid a lengthy application process.
Flexibility of terms
Hard money loans are convenient because they allow investors to get the money they need faster. The conventional loan process is quite slow, which could have investors waiting several months for loan approval. No real estate investor wants to miss out on a great investment property deal because they’re tied up in the system.
This is also a convenient loan option for house flippers. Did you know that a traditional bank sees homes needing significant repairs as high-risk investments? So when an investor is looking to flip a home, they likely wouldn’t be able to secure a loan using the traditional method.
Flexibility of Terms
Since private lenders don’t have to follow the rules of a traditional bank, they’re able to be more open to negotiation and structuring loan terms to fit your needs. This means an investor could finance their closing costs or negotiate a repayment plan more suitable to their needs.
Private lenders are also often more willing to overlook a low credit score, or lack of credit history, so a borrower's creditworthiness doesn’t have to prevent them from purchasing the property they want. Banks and financial institutions have certain rules and regulations in place that they have to follow, so they aren’t able to overlook factors like poor credit or inconsistent income.
Hard money loans require collateral. The collateral can be the asset that the real estate investor is looking to purchase, or it could be an existing property they already own. Collateral provides security for the lender; assurance that they’ll get their money back even if the borrower defaults on their repayment plan.
Collateral is also good for the borrower because it simplifies getting the property they need. Instead of worrying about factors traditional banks are looking for, a high-value asset could sway a private lender into taking a chance on an investor.
Disadvantages of Hard Money Loans
There are also some downsides to hard money loans; this type of loan won’t be ideal for every borrower.
Shorter repayment period
For Investment properties only
While real estate investors can secure their funds much faster, they will often pay more as a result. Interest rates are often much higher on short-term loans, not to mention closing costs for hard money loans typically run much higher as well.
Hard money loans also have a lower loan-to-value (LTV). LTV refers to the percentage of an investment property a lender is willing to fund. The lower this ratio is, the less they can approve. Private lenders limit how much they can provide in funding at around 50 - 65%, while banks and financial institutions generally are willing to finance up to 80 - 97%.
Shorter Repayment Period
Since hard money loans are short-term loans with a balloon payment due at maturity, investors won’t have as much time to pay them back. This could put a real estate investor in a tough spot financially if they do not have the proper exit strategy in place.
As a real estate investor, having an exit strategy is crucial. Common exit strategies to cover a short-term real estate loan for an investment property include selling the property, generating rental income, refinancing the loan, or a payoff from another source (i.e. sale of another asset).
For Investment Properties Only
A hard money loan can only be used to purchase an investment property. So, if you’re a borrower looking for a primary residence, you’ll need to seek a traditional mortgage loan and go through the standard process.
Banks don’t offer hard money loans because there is a very specific application process that all buyers go through to be granted loan approval, and they aren’t able to make the same exceptions as hard money lenders. However, you may be able to find local banks that offer short-term real estate loans, but these are typically reserved for clients with long-standing relationships with the bank.
When is a Hard Money Loan Right For You?
A hard money loan is best for real estate investors with a clear path forward and an exit strategy in place. It is also great for house flippers who want to purchase a home that needs significant repairs; most banks won’t lend money for homes that require upfront repairs. It is also a great option for investors who want to buy assets that cannot be financed with a traditional loan, such as condotels (condo-hotels) or vacant land.
Before applying for this type of loan, you’ll want to make sure you have a backup plan. No investor wants to end up in a situation where they’re stuck with a property they can’t afford and have no way of getting rid of it.
What Is an Exit Strategy?
All real estate investors should have exit strategies. An exit strategy is a way to back out of a real estate deal while (hopefully) losing as little money as possible.
Some common exit strategies include:
Refinancing. Many investors seek short-term financing in order to buy them time to qualify for long-term financing down the road.
A payout from another source. An investor can sell other assets (i.e. stocks, other property, business) and use the sale proceeds to pay off the loan.
Selling the asset. A real estate investor could also sell the property and use the sale proceeds to pay off the loan.
The Bottom Line
If you’re a real estate investor looking to move fast on a property to rent it out or flip it and resell, a hard money loan could be a good option. Traditional bank loans have more limitations and a longer approval process than a loan from a private lender.
However, it’s important to remember that short-term loans come with downsides, and you need to ensure that you partner with a lender that has a “lend to earn” strategy and not a “lend to own” strategy.
How Vaster Can Help
At Vaster, we want to ensure that you have all the resources you need to land your next investment property. We design custom solutions to fit every need, and when buyers and investors work with us — they close faster. We’re proud to call ourselves the one-stop shop for all your real estate needs.
Our skilled team makes the application process simple and is by your side every step. Whether you’re looking to refinance, get a commercial loan, or invest — we can help you get the funds you need to make the deal happen. Let's set up a call today.