The Pros and Cons of Hard Money Loans
The Pros and Cons of Hard Money Loans
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Hard money often gets a bad rap, in part because of its name, but the “hard” in hard money is a misnomer. Once you know the ins and outs of nonbank financing, hard money can actually be easier to obtain than other traditional financing, and so hard money becomes “smart” money. Smart money that helps borrowers in need of quick closings, borrowers who have to overcome credit difficulties, and borrowers who need short-term financing solutions for projects that do not fit the typical lending requirements.
There are three main benefits of hard money or private loans.
- Convenience – These loans can be obtained quickly with a minimum of red tape, especially when compared to the months that it can take to qualify for a conventional commercial mortgage that can potentially cost an investor a time-sensitive opportunity.
- Flexibility – Private lenders aren’t bound by the restrictions and federal oversight that banks are, so they can tailor loans to fit the project, such as including additional funds to cover loan payments during the term of the loan so that the borrower’s money can be focused on improving the property.
- Collateral – Hard money gets its name from the fact that the real estate asset typically serves as the collateral. What is unique about these loans is that private lenders can opt to base the loan amount on the after repairs value of the property if it is higher than the purchase price.
The key to using hard money and private loans effectively and profitably is to recognize situations in which the potential profits of the project will outweigh these costs. An extra 10 percent in interest over 12 months is nothing if you are expecting to get an ROI (return on investment) of 40 percent or more. Also, even though the repayment time period is shorter, most hard money and private loans are structured so that the borrower is making interest-only payments until the loan comes due, so the principal loan amount doesn’t have to be repaid until the property is ready to refinance or sell. What is important to keep in mind, is to have an exit strategy in place when you request the loan and to figure out the time you will need to achieve that exit strategy.
There are two main drawbacks to hard money or private loans:
- Higher costs – Borrowers pay for the convenience of these loans in the form of higher interest rates (sometimes as much as 10 percent more than a bank, though private lenders will sometimes go as low as 10 percent, depending on the circumstances) as well as fees and closing costs.
- Shorter loan terms – The main purpose of these loans is to bridge financing gaps and to allow borrowers the time to prepare a property to resell or refinance it, therefore the repayment period is much shorter than conventional loans, usually six months to one or two years.
If you have any questions about how hard money loans can benefit your project, contact Montegra at 303-377-4181.