Hard money is a form of alternative financing. When loans need to happen quickly, or when traditional lenders will not approve a loan, hard money may be the only option. Let's review how these loans work.
What Is Hard Money?
Most loans require proof that you can repay them. Usually, lenders are most interested in your credit and income. If you have a solid history of borrowing responsibly and the ability to repay loans, you'll probably have no problem borrowing money.
If you can't qualify for traditional loans, hard money may be an option. Hard money is a loan that uses an asset (or collateral) to secure the loan. Instead of evaluating a loan's risk based on your financial position, the lender makes sure that they can get their money back by selling your asset if you don't repay as agreed.
Hard money loans are generally short-term loans, lasting from one to five years. You wouldn't want to keep them much longer than anyway, because interest rates for hard money are generally higher than they are for traditional loans.
Why Use Hard Money?
If hard money is expensive, why would you use it? Hard money has its place for certain borrowers who cannot get traditional funding when they need it.
Because the lender is mostly focused on collateral (and less concerned with your financial position), hard money loans can be closed more quickly than traditional loans. They would rather not take possession of your property, but they don't need to spend as much time going through a loan application with a fine toothed comb.
Hard money agreements can also be more flexible than traditional loan agreements. Lenders don't use a standardized underwriting process. Instead, they evaluate each deal individually. Depending on your situation, you may be able to tweak things like the repayment schedules.
Qualifying for Hard Money
You do not need great credit to get hard money, and your income is not as important as it might be with other loans. It may even be possible to get hard money without verifying credit or income information, but it’s rare. Lenders will be interested in your finances, but your collateral is the most important thing.
Most hard money lenders keep loan-to-value ratios (LTV ratios) relatively low. Their maximum LTV ratio might be 50% to 70%, so you'll need assets to qualify for hard money. With ratios this low, lenders know they can sell your property quickly and have a reasonable shot at getting their money back.
In many cases, hard money is used to purchase and improve property. The loan-to-value ratios generally use a property's After Repair Value (ARV) - an estimate of how much it should be worth after the improvements are done.
Hard Money Drawbacks
Hard money is not perfect. While it seems simple - an asset secures the loan so everybody’s safe - hard money is only one option. It is expensive, so things have to work according to plan for profits to materialize. Hard money works differently from loans you may have used in the past. Lenders use more conservative methods to value property than you may expect.