What are hard money loans and how can they help you purchase property?

by Jasmin Suknanan

For most people, purchasing an investment property to rent or sell for a profit means first securing a loan. Most traditional mortgages stipulate that the owner occupy the purchased property, which closes off this avenue of funding for most would-be real estate investors.

Enter the hard money loan. This type of loan can provide you the cash needed to nab that enticing property, but it has many important differences from the mortgage loans with which you may be familiar. CNBC Select explains the ins and outs of the hard money loan to help you decide if it’s the right choice for you.

What is a hard money loan?

A hard money loan is a short-term loan that can be used to purchase commercial or investment properties. It’s also called a bridge loan and is typically secured by property (which means any default on the loan payments could result in the lender seizing your property). Unlike traditional loans, hard money loans aren’t funded by banks; instead, private investors and companies typically foot the bill.

How does a hard money loan work?

The main borrowers of hard money loans are people who want to purchase an investment property to buy and sell, for instance. Hard money loan lenders may check your credit score, but they also consider the value of the property you’re purchasing (remember that this type of loan must be secured by the property).

The repayment period of a hard money loan typically lasts from six months to a few years since it’s meant to be a short-term loan; traditional mortgages, by contrast, usually have repayment terms between 15 and 30 years. In other words, you’ll need to be certain of your ability to pay back the loan quickly before taking one on.

The interest rate on these loans is also usually much higher than that of a traditional mortgage and can range from 8%–15%. You’ll also likely make a significantly larger down payment at 20%–35% of the property’s value or its after repair value (ARV).

Lenders justify these expenses because, for the most part, hard money loans are easier for borrowers to qualify for and are processed quicker than traditional mortgage loans (meaning the lender takes on more risk). The turnaround time on a hard money loan, for example, usually happens in a few weeks compared to the months it can take for traditional mortgages to be buttoned up.

One of the simplest ways to go about securing a hard money loan is to talk to a real estate professional or a title company that can refer you to a lender in your area.

What are some alternatives to hard money loans?

Hard money loans may sound appealing because they carry shorter repayment terms and offer faster funding. But the higher down payment and interest rates can place these loans out of reach for those with more modest savings, particularly when you factor in the shorter repayment period.

If you’re looking to purchase property as an investment – whether you’re flipping the home or holding onto it for rental income — there may be other avenues you consider for funding.

Some lenders offer renovation loans aimed at borrowers purchasing a property that needs significant repairs. This type of loan saves you from applying for a mortgage and then separately applying for a loan to fund your repairs by rolling both of these loans into one product. Flagstar Bank is one lender that offers renovation loans, and CNBC Select also ranks it as one of the best lenders for construction loans.

You should also check out conventional loans meant specifically for financing rental or investment properties. Just keep in mind that even these kinds of loans may still carry higher down payment requirements or a higher credit score minimum.

Chase Bank offers a loan for rental properties that have up to four units and do not need to be occupied by the owner. This lender does have a 20% minimum down payment requirement that can also depend on the property type, loan size and your credit score.

Bottom line

While purchasing properties you intend to use for cash flow can be expensive, there is no shortage of ways to go about financing your venture. Hard money loans can be a solid route for those who prefer quick funding and short repayment terms despite the higher down payment requirement and interest rates.

But if hard money loans aren’t the best option for you, you can still consider renovation loans or conventional loans for rental properties, depending on what your goals are.

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