A hard money loan (HML) is a loan backed by real estate collateral. Usually, a hard money loan will have a slightly higher interest rate due to a higher-than-typical accepted risk of default. HMLs are usually short-term loans offered by individuals and companies that are not banks. Many borrowers choose HMLs over other types of loans because poor credit has less effect on a borrower’s speedy approval. Though often misunderstood, the hard money loan market provides unique opportunities for both lender and borrower.
A hard money lender provides an HML on a Loan-to-Value (LTV) basis. A real estate property’s value is determined by how much money a lender would get from its sale if the borrower were to default, forcing a foreclosure. HML lenders typically offer cash at an LTV ratio between 65% and 70%, or 65-70% of the current property cash value.
Despite the higher interest rates of hard money loans, many borrowers choose them for several main reasons. First, a borrower’s low credit score, or poor credit rating, has less of an impact on his or her approval for an HML. Second, HMLs have less strict standards than most bank loans, including a lesser need for documentation. Third, the HML approval process is often faster, which is very important to a borrower facing foreclosure, or requiring quick cash for other reasons. Finally, a borrower can use the HML as a “bridge loan” while waiting for other, more long-term financing. All these combined reasons may make an HML the best, or even the only, option for many borrowers today.
However, since HMLs carry higher risk of default than other loans, lenders must protect themselves. Along with requiring a higher interest rate, lenders usually take the first lien on the collateralized property. If the borrower defaults, then the first lean gives the lender the first legal right to the money from the sale of the real estate. This protection is especially important to the lender if the borrower has a lower credit rating, but it may deter a borrower from choosing this type of loan.
The hard money lending business in much more loosely regulated than other types of lending. Many laws pertaining to hard money lending are broad and general. However, there are a few cases where limits on interest rates are set low enough that the risk to the lender outweighs the benefit of doing business in that jurisdiction.
