Hard money loan requirements can be laxer than those for regular forms of financing—if a borrower has real estate to put up as collateral. But borrowers should be aware that this can be a loan with short payment terms and high-interest rates.
Is the speed of hard money loans worth it?
What Is A Hard Money Loan & How Do They Work?
A hard money loan is, in general, a short-term loan, and is a lot like a bridge loan. It is secured by real property (real estate) as opposed to something like equipment.
Payback terms are often short with a high monthly payment, and interest rates can be very high. This is why they are often seen as being loans of last resort. It is a way to raise money quickly and at a lower loan-to-value (LTV) ratio.
The loan term can be negotiated between the lender and the borrower, as these are inevitably coming from private lenders rather than traditional lenders such as banks or credit unions. The best hard money loans will allow for such negotiations between a borrower and a private lender.
Given the high value of land, hard money loans will attract a private lender because defaulting can be lucrative for the lender—because the lender gets to collect what you used to secure the rehab loan.
A hard money loan is a typical form of fix and flip loan. Because this is a quick form of business financing, a borrower can strike quickly. This is especially handy for land or housing sales at auction, where a buyer must be fast in order to win the property.
Usual Hard Money Loan Requirements
While private money loans will differ, these are the general requirements you’ll see.
Requirement 1 – A 600 or Better FICO Score
This is what is considered to be ‘fair’ credit. And this requirement is easier to attain than the minimum for more traditional financing, such as standard commercial loans.
If you are going to stay in the property, however, the risk increases to the private money lender. Commensurately, they will require more like a 680 minimum personal credit score.
If you can blow away the minimum credit score requirement, you may want to consider other types of financing and shop around. Commercial hard money loans just might not have to be a necessary evil if you have more like a 700 personal credit score. You may be able to get conventional financing from a traditional lender.
Requirement 2 – A Specific Loan to Value Ratio
This comes from how much you put down. You will often need to have a good 15% of the purchase price of a fix ‘n flip or 25% of its after-repair value to get a private money loan from a real estate investor.
But the numbers will be more like 25% for rental property or investment properties, or a refinance. They want you to be making a real estate investment, too.
Keep in mind: if you also need to borrow money in order to meet the down payment minimum, you will have two separate loans to keep track of—and two different ways you can default and lose your collateral.
In a hot housing market, this may be a chance worth taking. But in a slow market, it probably isn’t.
Requirement 3 – Closing Fees
Much like buying a home, there are going to be closing costs for anyone recently funded. Costs are going to vary, depending upon the lender.
You can expect to see origination fees of anywhere between 1.5% to 5% (or more). These will depend on the scope of the project.
And you can expect an interest rate between 3% and 6.50% and up. This is going to depend on your credit score and other factors.
The lower your personal credit score, the higher your costs are going to be. This will be the case with virtually any hard money lender you go to.
Requirement 4 – Bank Statements
Just like for a traditional bank loan, you are going to have to supply bank statements to an investor. A business with its own bank account will most likely have to supply bank statements from that account as well.
Hard money lenders are going to check your bank statements in an effort to determine if you will be able to pay all the costs and cover at least the minimum required down payment.
But as for the number of bank statements they will want to look at, that is of course going to vary by each hard money lender.
Requirement 5 — Prior Experience
While this is not a requirement of every single hard money lender out there, it is still relatively common.
Consider this from a lender’s perspective.
The lender is already taking a chance on you and your fair credit. And they are also taking a chance on the property, as many fix and flip properties start off distressed.
The absolute best hard money lender assurance you can give is proof that you have already been there, done that—and succeeded.
It not only shows you know how to get a property fixed up and ready for sale. It also shows you know how to price a property, best show it off to prospective buyers, and turn a profit in the industry.
Pros of Hard Money Loans
There are definite upsides to this form of business financing.
Pro 1 – You Don’t Need to Have a Good Credit Score to Qualify
Your creditworthiness (or the lack thereof) is immaterial. All the lender is going to care about is the value of the real property. Specifically, they are looking to determine if the after-repair value (ARV) will make a loan worth their while.
Real property, in essence, is the ultimate form of security for any private investor loan program.
Pro 2 – They’re Fast
For fix and flippers, in particular, time may be of the essence for making a purchase at a good price. Waiting around for a regular loan means missing out. Auctions, in particular, can move very quickly.
Unlike a traditional loan, the speed of hard money loans makes it possible to seize opportunities ASAP.
Pro 3 – Their Terms Can be Flexible
With private lenders, there can be room for negotiations as to terms. That kind of leeway is not going to happen with a conventional lender and a traditional loan.
A borrower can potentially negotiate on repayment terms, or have origination fees cut or eliminated during the underwriting process. With hard money lending, come prepared to negotiate.
Cons of Hard Money Loans
But there are some clouds mixed in with the silver linings.
Con 1 – You Don’t Have as Long to Pay Them Back
Standard hard money lending for real estate probably won’t go past a three-year term. But a commercial real estate mortgage term can potentially run up to twenty years.
For investors in it for the long term, having two decades to pay a loan back is helpful. But that won’t happen with a hard money loan.
Con 2 – The Higher Interest Rate on Hard Money Loan Rates
A borrower will quite literally pay a price for taking out a hard money loan.
In fact, the rate for hard money lending can be up to 10 percentage points higher than for a conventional loan. Origination fees, loan-servicing fees, and closing are also likely to cost investors more.
Con 3 – If You Default, It Can be Devastating
Of course, defaulting on any loan is going to be a problem. But when you default on a hard money loan, you will lose your collateral. Since that collateral is real property, it is a substantial loss. And it may even be substantial enough to put you out of business permanently.
Alternatives to Hard Money Loans
Of course, hard money loans aren’t the only game in town for real estate purchases.
Alternative 1 – Commercial Mortgages from Fannie Mae, Freddie Mac, or HUD
If your credit is not too bad, you may be able to qualify for one of these loans, issued by the government. You will generally have better financing options if you go this route. Fannie Mae and Freddie Mac require a 620.
For HUD, you will need to have a FICO score of 580 or better.
The repayment terms will be longer than for a typical hard money loan. And, at the same time, the rates will be less. These can be fixed rates or adjustable rates (ARM). A fixed-rate traditional mortgage can generally run from five years to thirty years.
Alternative 2 – The Credit Suite Credit Line Hybrid
For investors with a 680 or better FICO score, our Credit Line Hybrid is one of many viable loan options. And even if an investor’s own credit score falls short, they can still work with a credit partner or a guarantor.
Get up to $150,000, often at 0% APR for an introductory period. Most likely, this loan type will not finance the entire payment. However, it should cover most if not all of a down payment for many forms of real estate.
Even more conveniently, you get 24-hour approval. But you likely will not see the money for three weeks.
Alternative 3 – Commercial Real Estate Financing via More Traditional Loans
A loan has a lower loan-to-value ratio if the borrower puts down more as a down payment. If so, then term loans may be on the table.
It is possible to have a very bad LTV. When an LTV ratio is greater than 100%, a borrower is considered to be ‘underwater’ on the loan.
That is, when the market value of the property is less than the balance owed on the loan. LTVs over 100% are also possible early in the repayment period, on loans with high closing costs.
For a traditional loan, you’ll likely need an LTV of 80% or less.
Alternative 4 – Business Credit
Building business credit is an asset and it can get you various forms of financing, often at better terms and with lower interest rates.
While you probably would not use a business credit card to buy an investment property, you would use such a card to buy cleaning and carpentry equipment and supplies, and potentially also furnishings and appliances.
Having good business credit means you can make these kinds of ancillary purchases without having to take from your own funds or tack them onto any loan amount.
In case you’re wondering, the SBA 504 loan is for businesses to buy fixed assets like real estate. But it is not for speculation or investment in rental real estate.
In general, requirements for hard money financing are easy to meet if you have real estate. For the most part, a hard money lender will want the borrower to have a FICO score of at least 600.
Such a low FICO score means most loans are off the table—except for hard money.
Is a Hard Money Loan a Good Idea?
A person who wants to go into business but has poor personal credit may not have many alternatives. For them, it is not just a hard money loan that may be a good idea.
Going into real estate investment is also a good idea. A prospective business owner has a major piece of collateral and a well-known means of leveraging it for business financing.
This is something that going into business for yourself as a nail salon owner (or the like) cannot offer. For these people, hard money loans are a good idea.
But prospective entrepreneurs with better FICO scores would do well to explore other options and consider hard money loans as a last resort.
What can I use as Collateral for a Hard Money Loan?
Your collateral for a hard money loan is always going to be the real estate itself!
There are both positive aspects and drawbacks to this. For borrowers with fair credit, being able to put up real estate means they can get financing that they most likely cannot get elsewhere.
However, the biggest drawback is that you will lose that real estate if you default on a hard money loan. But then again, that is going to be the case with any other form of secured financing. A default means you forfeit the collateral.
There is a lot at stake!
What Credit Score is Needed for a Hard Money Loan?
For the most part, a hard money lender will want to see a FICO score of at least 600. This is considered to be fair credit.
Since the collateral securing such a business loan is so valuable, a bad credit score is less of an issue than for traditional loans.
For borrowers with bad credit, investing in real estate is a way to get your foot in the door and start a business. But no matter what, business owners should be looking to improve their personal credit and build business credit.
Better personal and/or business credit will open up many alternatives.