Hard Money Loan Requirements: Unconventional Financing Part 3

The Big Picture On Hard Money Loan Requirements:

• • Hard money loans offer quick, flexible financing for real estate investors but come with high costs and strict requirements.
  • If you need fast cash for a unique real estate project, hard money loans can close in days and offer flexibility.
  • Hard money lenders prioritize collateral over credit, which means they’re a faster option for investors with unconventional projects.

(This is the third article in our series Unconventional Financing. To start at the beginning, see Part 1 of the series on leveraging retirement accounts for real estate investing. Or if you’re looking for a hard money loan, visit our partner website, SparkRentalFunding.com.)

Lending is the second-oldest profession, as they say. For as long as there are resources that one person has and another wants, there are those who are willing to lend their resources for a fee or favor.

In what seems like another life, I was an account executive and lender’s inspector for a hard money lender. He was as ruthless as they come, but he was also experienced and intelligent and knew how to make money. A lot of money.

Hard money lenders charge high fees and interest on loans with a low loan-to-value (LTV) ratio. In plain English, that means they only lend 50-75% of the purchase price or property value.

But is there more to hard money than high costs and low LTV? What exactly are hard money loans?

What Is a Hard Money Loan and How Does It Work?

The definitions of hard money loans have blurred over the years. One definition is that the focus is more on the collateral rather than on the borrower. The idea is that the collateral property is so much more valuable than the loan amount that the lender will still recover their money even if they have to foreclose. But today, hard money lenders scrutinize borrowers more heavily than they once did.

By another definition, hard money lenders were often private individuals (or small businesses made up of a few individuals) lending their own or their investors’ private money. They were local people who lent money for local properties. Today, however, nationwide corporate hard money lenders use institutional funds to make loans.

Another standard definition is “lender of last resort.” Because really, why would anyone want an expensive mortgage that requires a lot of money down?

Yet that implies there are no advantages, which is not true. So why do people borrow hard money?

Hard Money Loans: Then vs. Now

For a better overview, here’s a quick general comparison between traditional hard money lenders then and modern ones. However, the numbers may vary from one lender to another. 

Typical Requirements for Hard Money Loans

Hard money lenders offer better flexibility than traditional financing. However, they still require borrowers to meet specific criteria — undoubtedly not as steep as conventional banks require.

• • Debt-to-Income (DTI) Ratio: Lenders prefer borrowers with a low DTI ratio, as it shows they’re more likely to pay back the loan. This applies to both regular banks and hard money lenders.
  • Credit Score: Most hard money lenders have a minimum credit score requirement. While it’s usually lower than what traditional banks ask for, a higher score can still boost your approval odds.
  • Down Payment: Hard money loans typically require a hefty down payment, often 20% to 30% of the loan amount. Although this can vary between lenders, it mainly reduces their risk.
  • Property Valuation: Since hard money loans are based on the property’s value as collateral, lenders will get an appraisal to determine its worth.
  • Income Verification: Lenders will usually want to see proof of income to ensure you can repay the loan. This might include bank statements or other financial paperwork.

However, these are just the typical requirements that hard money lenders expect from you. It may vary from one lender to another.  

(article continues below)

Real estate investments? Awesome. Being a landlord? Less fun.

Learn how to earn 15-30% on passive real estate investments in one free class.

Advantages of Hard Money

Quick closings matter when bargain-hunting for properties. The best hard money lenders can move at lightning speed. I’ve closed hard money loans in as little as three days. Imagine making a phone call and having a check for $100,000 three days later.  Few lenders outside the mob can move with such speed.

Beyond speed is flexibility: maybe you have a unique property you want to buy that most banks won’t help you with. Perhaps you’re converting an abandoned factory into condominiums or a church into a charming craft brewery. Or do you have special needs for a draw schedule for a renovation loan?

Hard money loans are short-term, so the high interest is very temporary. Often, a real estate investor will use a hard money loan to buy a shell, take draws to renovate it and sell or refinance it. The latter is necessary if you’re keeping the property long-term as a rental property. Either way, the initial hard money loan is usually paid off within a year. Hard money loans are often interest-only to reflect their temporary, bridge-loan nature.

Of course, some just don’t have a choice. Maybe the borrower has credit uglier than 1970s wallpaper or has too many mortgages to qualify for conventional financing. Renovation projects pose problems for borrowers, too, and hard money lenders tend to smile on rehab projects.

Disadvantages of Hard Money Loans

Hard money loans pose numerous challenges for borrowers. Interest rates typically range from 10% to 15%, far exceeding conventional mortgage rates of 3% to 6%.

On top of that, you’re looking at hefty upfront fees — 1% to 5% of the original borrowed amount, which means up to $5,000 for every $100,000 you borrow. Don’t forget about closing costs; they can easily surpass $5,000, depending on your loan size.

In addition, if you’re looking at a $100,000 property, you might only get up to a $50,000 loan due to tight loan-to-value (LTV) ratios of 35% to 50% as an industry standard. If paid off early, some hard money lenders include prepayment fees, but you might dodge this depending on your negotiation skills and the lender’s flexibility. 

Therefore, before diving into these hard money loans, make sure that the benefits you’ll get significantly outweigh the disadvantages of these quick-cash options.

Eligible Borrowers and Properties

Hard money loans can be an option for certain borrowers or property situations. Let’s see who’s in the market for these loans.

• House Flippers: These are the investors who buy fixer-uppers, beautify them up, and sell them for a profit. They sometimes opt for hard money loans because they can get cash fast — as early as 3 days. This speed increases their chances of winning when bidding on properties.
• Those Who Can’t Get Traditional Loans: Maybe their credit score took a hit after a divorce, or they’re self-employed and their taxes don’t show their true income. Traditional lenders might give them the cold shoulder, but hard money lenders often warmly smile at them.
• Homeowners in a Tight Spot: If you’re facing foreclosure but sitting on a chunk of home equity, some hard money lenders might throw you a lifeline. They’re betting they can still turn a profit if things go south.

The truth is that hard money loans are all about flexibility and speed. They’re not for everyone, but for the right borrower in the right situation, they can be a huge help.

Big Brother Has Spoken – Who “Need Not Apply”

It is probably worth noting that most hard money lenders today will only lend to real estate investors, not homeowners. In the wake of the Great Recession and foreclosure crisis, lending regulations grew much tighter on both the federal and state levels.

If you’re a homeowner, chances are no one will lend you hard money. Uncle Sam made that decision for you, to look out for your own best interests. Don’t you feel loved and protected?

But admittedly, Uncle Sam has a point that some people have no business being homeowners. For example, people with such poor credit that no subprime mortgage lenders will touch them, or those whose income is so low that they don’t even deposit it in a bank account. They should rent and build their credit rather than pay 14% interest for a hard money loan.

Hard money loans are useful for real estate investors when speed and agility matter more than cost. Most hard money lenders have seen it all and will have no qualms about telling you whether they think your deal is a winner or loser.

You’d do well to pay attention because they’re usually right. They’d have been out of business years ago if they didn’t know what they were doing.

What experiences have you had with hard money loans? Do you usually use a local lender or a larger national firm? ♦