As a specialized financing tool, a hard money loan is usually a common choice for real estate investors. Experienced investors know all about the pros and cons of private loans.
However, new investors must educate themselves on all the advantages and disadvantages of specific financing tools before they make a choice.
Before applying for any loan, the borrower must first know what they’re getting into and what risks are involved.
This article will present the critical advantages and disadvantages of opting for a hard money loan.
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Advantages of Using a Hard Money Loan
We all know people usually perceive hard money loans as a good option for borrowers with bad credit scores.
However, an investor may benefit from a hard money loan whether his credit is excellent or bad.
Some of the essential advantages of using hard money loans include the following:
1. Approval of Applicants with Low Credit Scores
Hard money loan lenders don’t make decisions based on the borrower’s credit score. Although some lenders still want to see their credit history, the approval or disapproval of a loan usually depends on the property’s value.
If an investor has a credit score of 650 (or higher), they will most likely get a loan from any private lender.
However, even if the score is lower than that, it still doesn’t have to be a deal-breaker. The investor may need the borrower to explain the credit score and still approve the loan afterward.
2. Quick Approval
Since there are fewer hard money loan requirements than traditional mortgages, the entire process takes significantly less time. A lender can review and approve a loan application AND fund it within 48 hours or less in some cases.
Hard money lenders like RBI mortgages focus on the property’s profitability, and they need less time to configure a loan than a bank. Moreover, when an investor establishes a working relationship with a private lender, they may get even quicker approvals and faster closings.
3. Designed for Fix and Flip Investments
The typical fix and flip property is in bad shape and comes at a low price. A hard money lender knows that distressed properties offer high-profit margins.
Moreover, hard money loans were designed to help fix and flip investors buy properties quickly, renovate them even quicker, and then sell for a good profit.
Unlike banks, which are less likely to approve loans on distressed properties, a private lender will gladly fund the project after getting all the plans and calculations in order.
4. No Prepayment Penalties
If a borrower completes their project earlier than predicted, they can pay back the loan before the term is over. Most private lenders don’t charge any prepayment penalty. They were designed for quick turnaround projects. It’s in everyone’s interest to get everything done quicker.
On the other hand, banks tend to make up their losses by charging hefty prepayment penalties, so many investors go for hard money loans.
Disadvantages of Hard Money Loans
No financing options are perfect, and while hard money loans may work for some investors, others may find them less appealing because of their disadvantages.
The disadvantages of using hard money loans include:
1. High-Interest Rates
The borrower’s convenience in getting instant access to funds and the lender’s high risk will always reflect higher interest rates.
Typically, the interest rates on private loans range anywhere between 7-12%. Even with a solid deal, the lender still takes on a significant risk by investing in a distressed property. While banks choose to take on low-risk deals only and offer lower interest rates because of it, hard money lenders secure their investments with higher interest rates.
2. Short Term Use Only
Usually, the terms of most hard money loans last for 1-2 years. Although there are longer terms available, two years is the standard upper limit for private loans.
The longer the term takes, the bigger the risk is for the lender because they don’t know how the interest rates will move in the future. It represents a significant risk for the lender to wait for a long time, offering only short terms.
3. Down Payments or Equity
Some investors see down payments as a deal-breaker that ultimately prevents them from applying for a loan. While hard money lenders may look past many issues, including bad credit and past shortcomings, they will require a down payment or equity in the property to secure the loan.
The term ‘hard’ in hard money symbolizes hard assets for securing the loan. With most hard money lenders, no down payment equals no loan approval.
Lenders typically expect to fix and flip investors to bring a down payment of at least 20% of the property’s purchase price. It’s sometimes hard for novice investors to come up with that amount of money, especially if they’re looking to flip in areas where properties are generally expensive.