What to Know About Hard Money Loans
When you’re serious about becoming a real estate investor, you need to have a good understanding of the various financing options available to you. One of these options is the hard money loan.
What is a hard money loan?
In real estate investing, a hard money loan is a short-term, high interest loan that’s based primarily on the value of the property, i.e. the “hard” asset that will be purchased. A hard loan is usually for a maximum term of 12 months. Additionally, the interest rate, the origination and closing fees are typically higher than with a regular mortgage. Hard money loans can only be obtained from private investors—traditional lenders such as banks, credit unions, and mortgage brokers, do not issue hard money loans.
What kinds of hard money loans are there?
A hard money loan can be structured in two ways: by using the loan to cost (LTC) ratio to determine the borrowed sum or by basing the sum on the after repair value (ARV) of the property. Here’s what you need to know about each:
An LTC hard money loan uses the total costs of purchasing and rehabbing the property as the foundation for the loan. It can be anywhere between 75 and 80 percent of the total costs. For example, you’ve found a property that costs $70,000 and needs $15,000 worth of renovations and improvements in order to sell it for $105,000. The total costs of the project would be $85,000. The lender offers you 75 percent of $85,000, which is a total loan of $63,750. You have to provide the remaining $21,250 yourself. If you sell the home at the projected price, you’ll have made $20,000, minus origination fees, closing fees, and interest.
An ARV hard money loan is based on the projected selling price of a rehabbed property, and usually amounts to between 65 and 70 percent of that sum. If you purchase a property at $110,000 and need $35,000 to sell it for $185,000, then a lender could offer you 70 percent of the selling price for a total loan amount of $129,500. You’ll only need to add $15,500 of your own money for the project to make a profit of $40,000 (minus interest and loan costs).
What types of properties can you finance with a hard money loan?
Hard money loans can be used for properties that aren’t intended for occupation by owner. Since they’re short-term loans, they’re most often used for fix and flip properties. However, they can also be used to finance residential rental properties such as single family and multi-family properties, as well as commercial rentals. Due to the high interest rates and fees, it’s best only to use them in the event you need short-term financing before you can apply for a long-term loan.
Hard money loans can be an integral part of your real estate investment financing strategy. Just remember to always take the time to research your options before you commit to the terms of any loan.
Related: 3 Reasons Why Investors Turn to Hard Money Loans
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