If you don’t qualify for a mortgage with a traditional lender, you might think you are out of luck. Maybe you heard bad things about
subprime lenders or you don’t qualify with them either. Whatever the case may be, you still have an option – it’s called a hard money loan.
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While the name makes it sound very intimidating, there are certain people that do well with this type of loan.
Keep reading to learn what you need to know to make the right decision for yourself.
What is a Hard Money Loan?
First, let’s start with the basics about the hard money loan.
Hard money lenders look at one thing – collateral. They
don’t focus on your credit score and income like traditional lenders do. Instead, they want to know what you have to offer them should you default on your loan. They don’t focus on your payment history or even evaluate your ability to repay the loan. As long as they know you have valuable collateral that they can sell if you default, they are good.
While how hard money lenders qualify you is a major difference from traditional lending, so is the term of the loan. With traditional mortgage lending, you borrow the money anywhere from 10-30 years. Hard money loans, on the other hand, are usually for a maximum of five years.
Typically, the interest rates on hard money loans are much higher than standard loans, so it may be a good thing that you must pay the loan off in such a short amount of time.
Should You Take a Hard Money Loan?
It’s hard to tell if you should take a hard money loan or not. On the one hand, it gives you the chance to secure financing when you might not otherwise be able to do so. However, it’s so expensive and risky, that you might think otherwise.
The most common situations when this type of loan makes sense are as follows:
- Purchasing an investment property – If you need short-term financing to buy a home and flip it, you will pay the hard money loan off fast. This gives you the chance to get the cash you need without paying excessive amounts of interest. The faster you can pay off the loan the better.
- Temporary financing – If you have a tight budget, you may need to get money fast for your home purchase. Let’s say you cannot get a traditional mortgage right now because of debt you are in the middle of disputing. If you need to buy the home now, you can take a hard money loan and then pay it off after you settle your credit and are able to get traditional financing.
When Shouldn’t You Take a Hard Money Loan?
If you are buying a home to live in and need to borrow a large sum of money to buy it, a hard money loan isn’t the answer. While you might think the interest isn’t that bad since you pay it monthly and it only increases your payment a little bit, you need to look at the big picture.
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Let’s say you pay $200 more in interest every month for the hard money loan versus a traditional loan. If you borrow the money for the maximum term of 5 years, that’s an extra $12,000 in interest you’ll pay. On top of that, though, the payment will likely be unaffordable since hard money lenders usually only offer a term of up to 5 years. Even if you find a lender willing to offer a longer term, that just means you’ll pay the excessive interest rate for a longer period, increasing the total cost of the home even more.
The Benefits of the Hard Money Loan
While a hard money loan sounds expensive, it does have its benefits, including:
- Less stringent requirements – As we stated above, hard money lenders don’t look at credit scores, credit history, or debt ratios. They focus on one thing – your collateral. This could mean you could get a loan with a
horrible credit score and outrageous debt. Of course, this probably isn’t wise because affording the loan might be nearly impossible, putting your collateral at risk.
- Faster approval – Traditional mortgage loans may take weeks or even months to get approved. Hard money loans, on the other hand, can take as little as a few days depending on the lender.
- Easy investment property loan – Investment property mortgages are often even harder to obtain because of the risk involved. Hard money lenders look at the value of the home and make sure there is enough value there to pay their loan back. This makes it much easier to get started on investment real estate.
The Downsides of a Hard Money Loan
There’s always a bad side to the benefits. The hard money loan has the following downsides:
- Costly – As we already discussed, you will likely pay much
higher interest rates with a hard money loan than any other financing option. You should look at the total cost of the loan before making a decision to ensure you can afford it and that it makes sense.
- Putting collateral at risk – Of course, you put your home at risk whenever you take out a mortgage, but you might have to put more than that at risk with a hard money loan. some lenders are pretty tough with their requirements, forcing you to put up more than you intended.
Whether you should use a hard money loan is a personal decision. Make sure you look at all aspects of the loan before deciding. What do you have to lose? How much will it cost? What are the terms of the loan? Once you know these answers, you can decide which route is right for you.
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