Hard money loans are short-term, secured loans that are used mainly by real estate investors to fund flip projects. They’re geared towards borrowers who need access to cash quickly and who want to bypass the strict qualification requirements of regular mortgage loans. Hard money loans come at a higher interest rate and a shorter repayment term, so they can sometimes be risky, especially if you don’t have much real estate investment experience.

What Are Hard Money Loans

Hard money loans are short-term loans backed by collateral, which is usually the property being purchased. Hard money lenders typically determine the loan size based on the property’s estimated value once the proposed renovations are done.

The main purpose of the loan is to finance upgrades and repairs to a property to increase the value of the resale. In most cases, the loan term is six to 12 months, though longer terms may be available in some instances.

How Do Hard Money Loans Work?

Investment companies, individuals, and other private short-term loan companies offer hard money loans, not traditional banks. Lenders typically require real estate as collateral for a hard money loan. In some cases, you can also secure the loan with other assets such as precious metals, equipment, and vehicles.

Most lenders do not evaluate your credit history to offer a quicker closing time but base the loan amount on the value of the collateral. You’ll usually be able to borrow up to 75% of the asset’s value to leave some room for profit for the lender if you default. Repayment for some hard money loans is structured as interest-only payments, followed by a larger balloon payment, which can make them riskier.

Why Use a Hard Money Loan

Hard money loans are usually appealing to borrowers who want to purchase an undervalued property and flip it in a shorter time frame. Quick funding allows such borrowers to purchase the property without having to go through the lengthy process of a conventional loan.

Hard money loans are also a good option for those who do not have W2 jobs, have lower credit scores, or are unable to meet the stringent mortgage requirements of traditional lenders. In some cases, borrowers use these loans to bridge the gap from the purchase of the property until they secure a traditional loan. This is especially true for buy-and-hold investors who are interested in renovating homes and using them as rental properties.

Interest Rates

When compared to other mortgage programs, such as FHA or conventional loans, hard money loans have a higher interest rate. Typically, you can expect to pay a 10% to 18% interest rate on these loans. There are other costs involved with the loan, which can make it more expensive. For example, you’ll need to pay 2% to 6% origination fees, which can make the loan quite expensive.  

Hard Money Loan Example

Here’s an example of how a hard money loan works.

Let’s say you want to purchase a property for $100,000, and the renovation costs are an estimated $20,000. The projected sale price for the rehabbed property is $180,000. The lender will lend you 70% of the projected value of the property after repairs. That’s $126,000 (70% of $180,000).

You’ll need to come up with a down payment of $5,000 and pay lender fees as well as origination costs, which totals $8,800 as an upfront cost. If the loan has an interest rate of 12% and the holding period is six months, you’ll pay an interest-only payment of $2,520 each month. If you successfully sell the property for $180,000 after six months, you make a profit of approximately $18,000 after accounting for the renovation costs, interest for six months, the principal amount you borrowed, and closing costs. You can use a hard money loan calculator to determine the total cost of the loan and your monthly payments.

Pros of Hard Money Loans

  • It’s easier to qualify for hard money loans since lenders do not usually check your credit report and have less stringent requirements.
  • The loan process is very quick, and you can expect funding in as little as ten days. This can be especially beneficial for projects with quick turnarounds.
  • Loan terms are shorter, so if you’re planning to repay the loan quickly, the higher interest rates will not matter as much.

Cons of Hard Money Loans

  • The loan-to-value (LTV) ratios are only around 50% to 75%, which can be much lower than conventional loans.
  • The interest rates are much higher at 10% to 18%, which are higher than even subprime mortgages.
  • Some lenders may not approve loans for owner-occupied residences due to compliance rules.
  • The higher interest rates and shorter terms make these loans riskier because if the flip project fails, it may be difficult for you to repay the loan.

“Hard money loans are very risky if you don't have your other investments and financials in line,” cautions Teresa Dodson, debt expert and founder of Greenbacks Consulting. “These are short-term and require payment in full quickly. Make sure you have the room to do this,” Dodson shares.

What You Need to Get a Hard Money Loan

When applying for a hard money loan, lenders will review a number of factors when evaluating your loan application to determine your eligibility, even though the underwriting guidelines are less stringent compared to traditional mortgages.

Credit Score and Financial History

Usually, lenders will require a minimum credit score of 600, but this can vary. In many cases, lenders may overlook your credit score and pay more attention to other factors, such as the LTV ratio, the value of the property, and your experience as a real estate investor. It’s also important to note that many lenders will require you to have enough cash flow so you’ll be able to make the monthly payments comfortably.

Types of Collateral

The collateral is the most important factor for lenders. For most loans, the property that you’re purchasing will serve as collateral for the loan. If you fail to make the payments, the lender can take possession of the property to recoup the money you borrowed. When you apply for the loan, the lender will ensure the property will have enough equity based on the after-rehab value (ARV).

Loan-to-value (LTV) Ratio

Lenders also look at the LTV ratio, which is calculated by dividing the amount of the loan by the property’s appraisal value. They review market comps to appraise the property after the rehab and will usually lend no more than 70% LTV. For example, if a property is appraised with an after-repair value (ARV) of $200,000, the lender will qualify you for $140,000. You can qualify for the loan if you can purchase, repair, and sell the property for $140,000 or less.

Alternatives to Hard Money Loans

Hard money lending has its own use, but in some circumstances, alternatives may be preferable. Fortunately, there are a number of other options to explore:

  • A home equity line of credit (HELOC) will allow you to turn your home into collateral and borrow against the equity. You can pay back the money over time, and the lien on your property will be removed once you pay it off in full. However, there’s a risk of foreclosure if you default.  
  • If you have a property in which you have built equity, you can take some of that money out and invest it elsewhere through cash-out refinance. You’ll have to repay the loan with interest over time.
  • Peer-to-peer loans are legal in some states, and they can provide last-minute financing through individual investors and private lenders. These types of loans are often expensive with high interest rates, but they can be helpful as a last-resort emergency loan.

The Bottom Line on Hard Money Loans

Hard money loans are usually used by real estate developers, flippers, and investors. These loans can provide access to funds much more quickly compared to traditional banks. The higher cost of interest is often offset by the fact that the loan terms are shorter. However, there can be significant risk if your investment is not successful, so it’s best to consider this option only if you’re an experienced investor and are confident in your ability to repay the loan quickly.