Hard money loan is an asset-based loan financing where a borrower receives credit which is secured by real property. Hard money loans are offered by privately owned organizations to people who are deemed ineligible to access credit facilitation from traditional lending institutions after failing to meet the threshold requirements. Typically, hard money loans are used to fund conventional commercial or residential properties. Due to the risk associated with hard money loans and the shorter payment duration, the payback interest rate is significantly higher as compared to the traditional lending institutions.
Projects funded by hard money loans last from few months to several years. Although many economists have associated hard money loans to bridge loans, the former has its distinct characteristics in that it does not only cover asset-based loans with high-interest rates but also covers distressed financial situations which may include arrears on existing mortgage or where bankruptcy situation is expected. One of the determinants of the loan amount that a hard money lender is able to lend is the loan amount divided by the value of the property. It is expected that hard money lenders will lend between 65-75% of the current value of the property under considerations.
The concept of hard money loans developed in the United States and Canada as a “last resort” alternative for properties owners seeking capital against the value of their holdings. The industry gained momentum in the 1950s after the United States credit industry underwent drastic changes. Although normally unregulated by federal laws, some state regulations have been developed to control interest rates, especially in Tennessee and Arkansas. The value of the property to be funded must be evaluated before the lending institution can proceed to provide hard money loans.
One of the main benefits of hard money loans is that credit history of the borrower is not a big issue. Private lenders do not emphasize highly on the credit history of an individual as a borrower with weak credit history can easily access hard money loans. This can be attributed to the fact that lenders base loan approvals on property value and borrower equity. Other flexible terms associated with this type of a loan include less initial requirements, zero prepayment penalties, faster loan approvals, and flexible payment terms among others.
Nevertheless, hard money loans have a significant number of demerits that limit their accessibility. One of the main disadvantages is that hard money loans have higher prepayment interest rates as compared to the conventional lending institutions. Higher interest rates are charged to compensate for the risks associated with this type of a loan. In addition, higher interests on loans lower the investors’ payback period on his or her investments.
Hard money lending institutions complement other lending institutions in the industry. However, they are flexible and slightly lenient as compared to other credit institutions although this is covered by their high interests on loans and short payment duration. Real estate investors have been growing their investments through hard money funding. This form of funding has significant benefits and potentially negative aspects.