If you’re here, you’ve likely heard the term “hard money” and want to know what it is and how it works.
Rest assured, we’ve created a comprehensive overview of all things hard money lending so that you don’t feel the way I felt when I first came across the phrase and wondered, “If hard money exists, what is soft money?”
Turns out, you don’t need to worry about anything called “soft money” when investing in commercial real estate. However, you’ll be happy to learn that “hard money” isn’t just some funny name. Instead, it’s a real financing option that can undoubtedly help you acquire a property as an active investor.
Here’s an overview of what we cover in this article. Feel free to skip ahead to explore the topics that interest you most.
Table of Contents
What is a Hard Money Loan?
A hard money loan is an accessible form of alternative financing that real estate investors and real estate developers can use to quickly access hard cash for the purposes of acquiring or renovating investment properties.
Hard money loans are short-term loans typically lasting from one month to a few years. Since hard money loans are arguably easier to get than a traditional loan but riskier for the lender, they usually have higher interest rates than a conventional loan.
Why is it Called Hard Money?
It’s called hard money because the hard money lender uses the borrower’s real estate asset, as collateral or security for the loan.
Using the investment property as collateral instead of assessing a borrower’s credit score or income simplifies the application process, allowing the hard money lender to quickly approve or reject the loan funds. In contrast to traditional lenders, this approach reduces the amount of time and red tape needed for qualification.
How Do Hard Money Loans Work?
For most hard money loans, borrowers need to present details about the project or investment property they want to acquire. Hard money lenders require this information to determine whether or not the real property will cover the cost of the loan if the borrower is not able to repay the debt. If the value of the property doesn’t cover the cost of the loan, or the lender doesn’t believe the investor has the experience necessary to successfully complete the project, the lender may reject the loan.
Additionally, the lender will assess the loan-to-value ratio, the condition and location of the property, the project plan, and other key indicators to determine whether or not they’ll approve a loan for the borrower.
If the loan is approved, the borrower will need to a large down payment (compared to a residential loan backed by the Federal Housing Administration), and then the funds will be released to the borrower according to the terms and guidelines agreed upon by both parties.
When the borrower receives the funds, they can use them as needed in their project or acquisition. However, it’s worth noting that if you’re a real estate investor leveraging this type of financing, you’ll need to work quickly because of the short repayment periods and higher monthly payments.
What is the Purpose of Hard Money Loans?
Compared to traditional financing options, the approval process of hard money loans is typically quick. As a result, the main purpose of hard money is to provide financing for borrowers who need capital rapidly. Additionally, since hard money lenders require fewer personal qualifications (such as credit history) than most lenders, hard money also provides individual investors who have poor credit with a realistic way to purchase investment properties.
For example, let’s say a small group of private individuals find a great deal on a small apartment building and only have a few days to make an offer. In this situation, the investors can quickly create a project plan, take the details to a hard money lender, and potentially receive a secured loan within a matter of days (rather than weeks) to purchase the property.
After the investors acquire the commercial property and complete efforts to increase the value of the property, they can refinance into a longer-term, traditional loan with better terms and repay the hard money loan.
Do You Need Good Credit for a Hard Money Loan?
No, you do not necessarily need good credit for a hard money loan. Depending on the lender, they may focus more on the asset being used as collateral than your credit. Hard money lenders typically look at things such as the loan-to-value ratio (LTV) and the condition of the property to make their decision rather than a credit score. So while having good credit can help when applying for any loan, it’s not necessarily required to to receive a hard money loan.
Hard Money Loans vs. Traditional Loans
A hard money loan is similar to other types of commercial real estate loan products in that they provide financing for specific projects or commercial properties. However, a hard money loan is different than financing options from traditional lenders in four key ways:
First, a hard money loan usually has a higher interest rate than a traditional loan.
Second, a hard money loan typically has a shorter repayment period than a conventional loan. As an example, a conventional mortgage may have a repayment period of five to 30 years, whereas a hard money loan typically has short repayment periods ranging from one month up to a few years.
Third, hard money lenders tend to focus more on the asset being used as collateral rather than the borrower’s credit, which makes them desirable for borrowers with lower credit scores.
Fourth, hard money loans typically require larger down payments than other financing forms, such as government-backed mortgages.
Who is a Hard Money Loan Best For?
Hard money lending is best for borrowers who:
- Have lower credit scores
- Need financing quickly
- Need a short-term loan
- Need extra cash to cover renovation costs or their debt stack
The Pros And Cons Of Hard Money Loans
Making a wise decision about hard money loans begins with reflecting on the advantages and disadvantages. To explore the information necessary to make an informed choice, here’s a list the major pros and cons of hard money loans to help you determine if they suit your needs.
Hard Money Loan Pros
1. Quick access to cash for short-term needs
2. Less stringent approval process compared to other loans
3. Not dependent on the borrower’s credit history
4. Lower closing costs and fees compared to other loan types
5. Flexibility in repayment terms
Hard Money Loan Cons
1. Higher interest rates than traditional loans
2. Shorter repayment terms
3. Larger down payments compared to other forms of financing
4. Can be difficult to obtain for riskier deals
5. May not be suitable for long-term needs or projects
Do Hard Money Loans Require Down Payment?
Yes, hard money loans often require down payments. While the amount of the down payment depends on the lender and project, these types of loans typically require higher down payments than traditional mortgages
Finding Hard Money Lenders For Real Estate Investing
There are many ways to find hard money lenders for real estate investing. You can search online using keywords such as “hard money lenders” or “real estate financing,” which should provide you with a list of experienced hard money lenders.
Another way to find hard money lenders is to network with real estate investors and private lenders in your area and ask who they work with for hard money loans.
What Are Typical Hard Money Terms?
There are three key areas that often differentiate a hard money loan from traditional loans: Interest rate, repayment term, and down payment. Let’s take a look at each.
1. Typical Hard Money Loan Interest Rates
Hard money loan rates typically come with interest rates that are higher than those for traditional mortgage loans. The exact rate may vary depending on the type of loan and lender, but interest rates for hard money loans can range from 7–19%.
That being said, it’s worth noting that rates fluctuate depending on market trends and your individual financial situation.
2. Typical Hard Money Loan Repayment Terms
Typical repayment terms for hard money loans are usually 12 to 18 months, but may be as short as one month or as long as five years. The lender will usually require the borrower to make monthly interest payments, with a balloon payment due at the end of the loan’s term that pays off both the principal and any remaining interest owed on the loan. Hard money lenders usually charge higher interest rates than traditional lenders, so it is important to have a repayment plan in place before signing up for a hard money loan.
With the way hard money loans work, it’s also possible to request interest only payments for a specific period of time or for the duration of the hard money loan. Utilizing interest only payments can help investors manage their monthly costs or ash flow during a significant renovation period or as they work to stabilize the rental property.
3. Typical Hard Money Loan Down Payment
The amount of a down payment on a commercial hard money loan typically depends on the lender and type of loan. Generally, you can expect to put down at least 20-30% of the total purchase price to secure a hard money loan. Some lenders may require higher percentages depending on the borrower’s experience or where they are purchasing a property.
What is Hard vs. Easy Money?
As mentioned earlier, “soft money” isn’t a phrase you’ll hear in commercial real estate investing. However, if you’ve heard the phrase “easy money” before, you may be asking—what’s the difference between hard money and easy money?
Hard money loans are asset-based loans that come from private investors, rather than traditional banks and lenders. The advantages of hard money loans include quick closings, flexible terms, and easy access to capital.
Easy money is any loan with lenient requirements that generally requires little or no collateral, such as online installment loans or payday advances. These types of financing usually carry higher interest rates and fees compared to hard money options and are more commonly found in the personal finance world (e.g., credit cards).
When To Use Hard Money For Real Estate
When purchasing a commercial property, all financing options are deal specific. If you find yourself in situations where it’d be advantageous to secure conventional mortgages, get the conventional mortgages as they’ll likely come with slightly better loan terms. On the other hand, if you find yourself in a situation where you need money quickly, or your credit history is preventing you from securing a traditional mortgage, explore hard money loans to see if they’re right for you.
Hard Money Lenders: What To Know About Working With Them
Hard money lenders are private investors who specialize in higher-risk, short-term loans. Unlike a traditional lender or local bank, a hard money lender does not need to comply with the same regulations as a traditional bank. As a result, the hard money lender can make their own decisions about credit score or income requirements for borrowers that may otherwise be unable to secure financing elsewhere.
When communicating with private hard money lenders, keep in mind that they are private investors just like you—often putting their own capital on the line and seeking to make a profit. As you explain your project and yourself as an investor, recognize that these lenders may be less restricted by institutional guidelines than other traditional sources of funding. Forming a partnership with them begins with being honest and clear about who you are and what you’re proposing; this is key for convincing them to lend to you confidently.
Alternatives to Hard Money
Aside from working with traditional financial institutions, other alternatives to hard money loans include bridge loans and seller financing.
A bridge loan can be considered similar to a hard money loan because it’s a short-term loan used to cover a debt until the investor(s) can secure longer-term financing.
Seller financing can serve in a similar way as hard money if the seller is willing to utilize their equity in the property as a way to loan the money to the buyer for an agreed-upon timeline and charge interest on the capital.
Hard money loans are an important tool for commercial real estate investors. They provide a way to access capital quickly and can be used in situations that may not qualify for traditional financing. However, the cost of borrowing using hard money lending is high compared to other options, so it’s essential to carefully consider the risks associated with this type of loan before making any decisions. As long as you understand what you’re getting into, hard money financing could be a great solution for your business needs.