A hard money loan is a loan that is primarily secured by the equity in a Hard asset…most commonly real estate. A Hard Money loan is also called an Asset-based loan. A hard money lender focuses primarily on the asset as the source of repayment. Because of that the underwriting of the borrower is greatly reduced which allows the loan to be made much more quickly. Conventional lenders and banks are not allowed to make asset-based or hard money loans since they are required to strictly underwrite the borrower in order to sell or insure their loans. Private lenders are generally the ones offering hard money loans and they can be individuals or groups of individuals. Hard Money Loans are not insured or purchased by government institutions and thus carry a higher risk to the lender. This risk means that the cost of the loan or the interest rate paid on the loan will be higher. Hard Money Loans are generally shorter in duration and commonly last 2-years or less.
A Hard Money Loan has both pros and cons which are described in our article “Pros and Cons of Hard Money”. We describe situations in which a Hard Money Loan may make sense in “When to use Hard Money”. We have also written articles detailing “What are the costs of a Hard Money Loan” and “Hard Money Lending Terms”.
In this article, we will seek to clearly describe what a Hard Money Loan is, what it is not, the collateral needed, the steps to secure one.
A hard money loan is a loan that carries many names: Asset-based loan, Bridge Loan, Short-Terms Loan, or Private Loan. While it is called many things it is really just a loan where the collateral is the primary source of security and repayment and which Real estate is the collateral.
When real estate is used as the collateral the lender will be lending on the equity of the property or the difference between what the property is currently worth and the loan that is being requested. Because real estate values (like all assets) can go up and down in value, Hard Money lenders generally do not make 100%, 90%, or even 80% LTV or “loan to value” loans. Most Hard Money Loans will require that there is at least 35% or more equity in the property before considering a loan. The reason for this large equity requirement is a direct result of the 2008 recession in which property values fell between 20% and 50% in some areas. If you do not have or cannot create sufficient equity in the property it will be hard to get a Private Lender to make the loan. A Private Lender is going to want there to be enough equity in the property to ensure that the property could be sold to repay the loan across any reasonable value or market changes.
In the lending world, hard money loans can be considered a risky loan when compared to a conventional or government-backed loan. In Conventional or government-backed loans the lender is generally selling the loan to the secondary market or getting insurance that guarantees the loan if the borrower does not repay it. With a Private Loan, there is no ability to get insurance on the repayment of the loan. The lender is also taking additional risk by offering less rigorous borrower underwriting requirements. See our article “Hard Money VS. Soft Money” which explains the conventional underwriting requirements and details what a Hard Money lender is giving up in order to grant a borrower a hard money Loan. Because of the risk associated, the interest rate charged on this type of loan will be higher than a conventional loan. On average a borrower can expect to pay upfront points or origination fees and between 9% to 15% annualized interest.
The positive aspect of this type of loan is that a borrower can access the equity quickly in a home they own. They can also get a loan that presents the same as a cash offer to a seller. With cash in hand, a Hard Money Loan can enable the borrower to buy discounted investment properties or foreclosure sales that require cash or a quick close to participate in. There are also instances in which a borrower has equity or significant cash but does not otherwise qualify for a conventional loan. No matter the WHY behind the loan, most Hard Money borrowers are going to use the money for a short period of time. It is common for the borrower of a Hard Money loan to either sell the property for a profit or have a strategy to refinance the loan at some point in the nearer future.
As discussed, a Hard Money Loan is a loan from one person to another. Therefore, the process, terms, costs, and expectations will vary from lender to lender. In general, a Hard Money Lender should have a clear process that they can describe and be able to provide capital quickly. Most good Private Lenders can make a Hard money loan in 2 to 7 business days. While individual private lenders are out there, they can be harder to find and work more by word of mouth or through Brokers. They generally have limited capital $500K to about $5M and will commonly run out of money or be “lent out”. Private Lenders who have a larger source of capital say between $20M and $100M will commonly start a Private Lending company. Lending this amount of capital generally takes employees, software, systems, and processes to efficiently lend and service that size portfolio. Northwest Private Lending (NWPL) is a direct lender with a single decision-maker who employees a team of people to help lend out their own money.
That being said Private Lender’s sources of capital can vary. Some lenders lend their own money, some lend others, some borrow from banks, while others use Crowd Funding or Pooled Equity Funds. All these sources will allow a Private Lender to provide a hard money loan. However, be aware that where the money comes from matters. The number of decision-makers will also dictate the steps required to get a loan. The source of money will also affect the flexibility the servicer has when managing an existing borrower who runs into challenges.
It is the recommendation of this author to get to know your lender and to work with a lender who is well known and has a good reputation in the community. An unethical or greedy lender can make for a very negative business experience. While a fair and trustworthy lender can enable a borrower to make a great profit. Because of the way that people treat other people can vary, we suggest reading “What To Look For in a Private Lender” before selecting a Private Lender.
With most Private Loans, the borrower will be working directly with the lender. This can be an individual, a group of individuals, or a company whose purpose is lending out private individual’s money. Knowing where your lender gets their capital is important and it is okay to ask. We also suggest that you ask the person you are working with if they are the same person who is funding your loan. NWPL is owned by Eric Larson who is also the loan originator. If you work with NWPL, you will be working directly with the person controlling the capital and making the decision to fund or not fund your loan.
If you are working with a larger lending company, then you are most likely working with a loan originator. A loan originator’s job is to take the borrower information and package it up and present it to an underwriting department or governing body who represent the Private Lenders. These individuals are in charge of the capital and will say yes or no to your loan. It is rare that a borrower will get to talk directly with this group. All that to say, loan originators can’t really guarantee they will fund a loan without this approval. Be aware that the farther you are from the source of capital, the greater the steps to get the loan approved and funded
If you are working with a Broker, that means that they are not a lender and do not work for a direct lender. A broker is an individual who is well connected to many private and conventional lenders. Sometimes they will make an introduction or take over as the originator…but for a fee. It is common for a broker to charge ½% point up to 2% of the loan amount. This will be in addition to the Lender’s charge. An article has been written to describe a “Direct Lender VS Broker” which highlights the pros and cons of working with a Broker.
In summary, a Hard money loan is not designed to compete with the conventional lending space. They are not designed for the purchase or refinance of primary residences. They should not be considered if the borrower needs to keep the loan for a long time. If you do not have significant cash or equity in a property a Hard Money loan is not going to be a fit.
Conventional lenders and banks don’t want to make short-term loans and Private lenders fill that lending gap with the Hard Money Loan. When you own or are purchasing investment real estate and you either have significant equity or cash to put down a Hard Money loan can offer the borrower reduced underwriting and a fast close. Working directly with a lender to get quick cash can enable a real estate investor to take advantage of deals that they otherwise would miss out on if their only options were conventional lending.