The 30-year fixed-rate mortgage is the most popular lending product in America, as it allows borrowers to lock in an amortized rate for a long period.
However, with the higher interest rates in today’s fast-moving economy, this mortgage might not be the best fit for real estate investors.
Alternatively, hard money loans (also known as private money loans), while accompanied by higher interest rates, can offer borrowers more flexibility, speed of funding, and easier lending requirements, which can be appealing to real estate investors alike.
Investors betting on interest rates dropping within the next 12 to 24 months might be able to capitalize on purchasing a property with a hard money loan and then refinancing into a 30-year fixed-rate mortgage once interest rates drop, helping to secure lower monthly payments for years to come.
Here are the three most significant advantages of using a private money loan over a long-term mortgage.
1. Asset-Based Lending
Traditional mortgage lenders require a borrower to meet specific criteria and check a laundry list of boxes, including:
Credit score Income
Debt-to-income ratio limit Tax returns
Bank statements Property appraisal
Failure to meet one or more of these requirements can result in an automatic rejection of your mortgage request.
While a hard money loan is unconventional, it is more straightforward in terms of lending requirements.
Hard money lenders are most interested in the underlying value of the property and the loan-to-value (LTV) ratio the borrower is asking for.
Example:
Asking a hard money lender for $500,000 against a property valued at $1,000,000 would be a 50% LTV, which would be attractive to the lender since the value of the asset to the value of the loan is the most critical factor in determining if the lender underwrites the loan.
Loan-to-Value (LTV) and Your Likelihood of Approval:
50% LTV or lower: Your chances of securing funding are very high. This level of equity significantly reduces the lender’s risk.
50%–70% LTV: Approval is still very likely, especially if the property is located in a major, stable market like Los Angeles, New York, or San Francisco.
70%–80% LTV: At this range, lenders may require additional security, such as cross-collateralization with another property or proof of strong liquidity/assets on your balance sheet.
100% LTV: This is extremely rare and often a red flag. Legitimate hard money lenders seldom fund deals with no equity. Be cautious — this could signal a scam.
Keep in mind, the majority of hard money lenders won’t lend against land or owner- occupied properties, but usually they are more than happy to lend against:
- Single-family homes and multi-family properties (duplexes, triplexes, 4-plexes) Apartment buildings
- Mixed-use properties
- Retail buildings & office buildings Industrial/warehouse properties Rental properties
- Assisted living facilities Self-storage facilities
By focusing on a borrower’s equity in a property and the overall property value, asset- based lending allows borrowers to unlock capital that would otherwise be out of reach, enabling them to buy, renovate, or refinance without the thick red tape of a traditional bank.
2. Flexible Lending Terms
Big banks don’t offer hard money loans; it’s not a financial product that fits their often myopic and narrow lending criteria.
This gap in mortgage financing has created a secondary market for hard money lenders to offer real estate investors more creative funding methods.
Hard money lenders are often comprised of private individuals, family and friends, investment companies, or small firms, who can customize the lending terms to the particular borrower’s needs.
Here are some of the terms that are often included in these loans:
Interest-only payments – Helping to reduce cash-flow issues
Balloon payments – Allow a borrower to pay off the entire loan at a future date upon the sale or refinancing of the property.
No minimum credit score – A less-than-perfect credit score is acceptable with a strong loan-to-value (LTV) rate and an asset with a good property value.
Cross-collateralization – Borrowing against multiple properties at the same time in a single loan can help increase borrowing power for the borrower/investor.
Short Duration – Loans from 6 to 24 months are perfect for fix-and-flip investors or those looking to purchase a new home while waiting to sell their current one
Perhaps one of the most powerful concepts with hard money loans is the flexibility in how fast they can be evaluated, approved, and underwritten.
Whereas obtaining a traditional bank loan can often take months, a hard money loan can be processed in as little as 5 to 7 days, allowing real estate investors to secure a property quickly and stay competitive in today’s fast-moving property market.
Hard money lending also cuts through the red tape and places less emphasis on the borrower’s financial situation, but instead on the value of the asset being borrowed against.
This makes hard money an ideal solution for real estate investors who:
Own high-value properties but can’t meet traditional documentation requirements
Are self-employed or have non-traditional income
Have a poor or limited credit history
Need to move quickly on an opportunistic property purchase without waiting for underwriting approval.
3. Bridge Funding Between Transactions
Sometimes, timing is a critical factor in an investment deal. If you also have a liquidity gap, a bridge loan can often be a great solution, even in cases where a borrower checks all traditional banking requirements.
Even though banks offer the best interest rates, if a borrower needs quick financing to close a deal, they often can’t endure the 30 to 90-day evaluation, closing, and underwriting process, making hard money loans a faster, more practical solution when timing is critical or a hot deal comes on the market.
Example:
A homeowner wants to purchase a new home but doesn’t have the funds to do so without the sale of their current home.
In this scenario, a hard money bridge loan can provide the capital needed to purchase the new property without relying on the sale of the old one.
With bridge financing, homeowners can tap into existing equity in their current home to fund their new purchase without having to wait for other assets to sell.
Once the original property sells, the loan is typically paid off in full.
Added Bonus:
From the home seller’s perspective, an offer using hard money is often an all-cash offer, which is a seller’s dream. Paying all cash will help your offer stand out from competitors’ offers and eliminate the need for a lengthy approval process for the buyer to get bank approval.
In Conclusion
In conclusion, hard money loans aren’t for everyone, but if you find a great deal you believe will sell quickly or find yourself in a temporary liquidity crunch, these types of loans can be advantageous over traditional financing for the right real estate investor.
When used methodically, hard money loans can help you to act quickly, free up liquidity, and be competitive in a tough real estate market.