Pros and Cons of Hard Money Loans

What Is a Hard Money Loan?

A hard money loan is a type of short-term loan secured by real estate. It is typically used by real estate investors to buy, build, or improve property rather than being used to finance long-term mortgages. It is often a much quicker way to finance the purchase of new properties.

Pros of Hard Money Loans

Here are some advantages of utilizing hard money loans:

Lower Risk

One of the main benefits of a hard money loan is that it is often considered a lower risk investment as lenders only use a portion of the purchase price to loan money. Generally speaking, borrowers have to provide anywhere from 10 to 25 percent of the total cost of the property as a down payment and the remainder can come from the hard money loan itself. This means the investor’s risk is limited.

Shorter Timeframe

When investing in real estate, time means money. Hard money loans offer a much shorter time frame when compared to other loan types. Generally speaking, hard money lenders can finance a property in two to three weeks whereas traditional lending institutions may take months. For an investor, that timing can make the difference between a promising opportunity and a missed one.

Higher Loan-to-Value Ratio

Another benefit is the higher loan-to-value ratio that is offered by hard money lenders when compared to banks. Usually, hard money lenders provide loans up to 65 to 80 percent of the loan-to-value ratio.

Cons of Hard Money Loans

There are some drawbacks of a hard money loan:

High Interest Rates

Another major downsides of hard money loans is they often come with much higher interest rates than traditional mortgages. Depending on the lender, hard money loans can range from between 8 to 16 percent. That’s much higher than the 4 to 5 percent annual interest rate a borrower may get with a traditional loan.

Short Loan Terms

In addition to the high interest rates, hard money loans traditionally come with short loan terms. In most cases, these loan terms are for one to three years, with the average length of about one year, as opposed to the 30 year terms you will usually see with mortgages. This can be best for an investor but it can leave them scrambling to refinance a property or to otherwise manage the short-term loan burden in a timely fashion.

Few Repayment Options

Lastly, hard money loans usually offer limited repayment options. If a borrower defaults on a loan, the lender will typically have the right to foreclose on the investment property, which leaves the borrower with few options.

The Bottom Line

Hard money loans can be useful tools for real estate investors. While it is important to consider the pros and cons of a hard money loan carefully before committing to one, it can often be the best and most efficient way to finance a property in a short amount of time.