A hard money loan is the primary source of funding for fix and flip investors. These are high-interest, short-term loans ideal for flipping an asset. Let’s dive in.
If you’re starting with real estate investing, you might be wondering how in the world you’ll ever come up with enough money to buy your first property. Do you need to get a mortgage? That seems like a lot of work for a house you don’t plan to keep for very long.
This is where hard money loans shine. These loans are great ways for investors to get the financing they need for purchasing the home, repairs, carrying costs, and other things that go along with fix & flips.
If you’ve never used a hard money loan, you might feel apprehensive about getting started. “What are these loans, and can I get one? What’s the catch?” Luckily, I’ve got you covered. This guide will give you all the ins and outs you need to know about hard money loans and what you can do to ensure you’ll be approved so you can get started flipping ASAP. Let’s dive in.
What is a Hard Money Loan?
Hard money lenders are different from traditional banks. Their loans are designed for real estate investors who need financing to cover the costs of purchasing and repairs for a fix & flip. Typically, these are typically for short-term use. Lenders in this industry rarely require you to have good credit or solid employment history as they’ll use the property for collateral to mitigate the risk instead.
Hard money loans are paid in monthly installments like any other loan. Your lender will expect to have your loan paid in full either through the sale of the property or by funds you receive if you get a mortgage on the house or building.
How is a Hard Money Loan Different From a Mortgage?
On the surface, hard money loans and mortgages don’t appear to be much different. Both are loans used to purchase a property when you cannot offer cash directly from your profits or savings. But the similarities stop there because hard money is so much more efficient as a funding source for fix & flips or BRRRs.
Why Hard Money is Better than a Mortgage for Real Estate Investing
The most significant difference when it comes to these types of loans is that hard money lenders rarely require you to have an impeccable credit score, strong employment history, or spotless background checks. If you’ve ever applied for a mortgage before, you know how cumbersome it can be to ensure you’re an attractive enough candidate for a mortgage approval; hard money lenders remove those obstacles completely.
Another reason many investors will opt for hard money loans instead of mortgages is the speed of funding. The average hard money loan can be funded within a few weeks of application, and some may only take a few days.
Why Hard Money Might Not Be Right for You
As with most things, while hard money loans are great deals for investors, there’s a few catches you should know about before deciding to use one as a replacement for a mortgage.
- Hard money loans are only for short-term use. Many lenders will want the loan paid off in 6 months to 2 years.
- Hard money loans have higher interest rates than mortgages. Hard money loans are often either paid off with the profits from the sale of a property or funds given through a mortgage. Since the lenders expect to be paid back quickly, the interest rates are higher than a traditional mortgage. Consider it as a way for your lender to motivate you to get this loan paid off as quickly as possible. Rates vary, but the average rate in 2021 was around 11.25%.
- Hard money loans use your property as collateral. Hard money lenders need to mitigate their risk since they’re less reliant on your background and credit history, so they’ll typically take a position on the title until their loan is paid in full. If you’re trying to get a mortgage on top of a hard money loan, it could be difficult to be approved since there’s already another lender with a first or second position listed on the title. Also, if you’re unable to pay off your loan, the hard money lender can seize your property.
- Hard money loans are rarely for the full purchase price. Typically, lenders will look to fund about 60% – 80% of the current property value. The Investor's Edge is different because we offer 100% funding, but we’re the exception in the industry.
Can I Use Hard Money to Buy My Own Home?
If you’re considering getting around the traditional mortgage requirements, you might be wondering if hard money loans are an option.
In theory, yes, you can use a hard money loan instead of a mortgage. There’s nothing legally preventing a hard money lender from working with you, and the seller probably won’t care where the money comes from, as long as the wire transfer clears.
That said, using a hard money loan to replace a mortgage is probably not the best financial decision you can make. Let’s say you’re purchasing a home for $100,000. With a mortgage, you’d have 30 years to repay that with a 3% interest rate.
With a hard money loan, you’d have three years to pay that off with an 11.25% interest rate. Are you willing to take the gamble that you’d be able to come up with an extra $100,000 + 11.25% within 24 months?
Even if you are, it could be difficult to find a lender that’s willing to take you on as a client. Hard money lenders fill a specific role in real estate that’s tailored toward investors instead of retail buyers. Consequently, their business model is based on projected profits received from the investor selling the house. If there’s no profit to be made, then the risk for the lender is much higher, which will make getting a hard money loan incredibly difficult. I won’t say impossible, but it’s as close to impossible as you can get.
What Will I Need to Qualify for a Hard Money Loan?
Each lender will have its own requirements for what you’ll need to bring to the table for your loan to be approved. Here are a few things you should have ready to go beforehand to better increase your chances.
A Down Payment
If this is your first hard money loan, you’ll need to have some money available to put down as a way to secure the loan. Each lender has its own requirements, but the minimum you’ll need is generally around 25% – 30% for residential properties and 30% – 40% for commercial properties.
If you have a lot of experience or have a long-standing relationship with the lender, you may be able to use collateral from another property as your down payment. This is called “cross-collateralizing” and is an advanced way to navigate getting a hard money loan without putting down cash.
At The Investor's Edge, we have no minimum down payment required, meaning for great deals you can close with $0 cash-to-close (which 37% of of our borrowers did in 2020)
Prior Experience Successfully Flipping Houses
While we’re happy to work with new investors, understand that many hard lenders want some kind of experience under your belt to help mitigate risk. If this is your first fix & flip, try to bring as much of a written plan with you as possible. This includes estimates on costs, projection of value (and how you came to that number) AKA “ARV,” your exit strategy, current financials, and anything else you think might be helpful to show how serious you are.
Again, The Investor's Edge doesn’t require any prior experience.
The healthier your financial situation looks, the more likely you will be approved for a hard money loan. Lenders will want to see that you have some money available to make payments, handle carrying costs, pay yourself, etc.
If you don’t have a good financial history, there are a few strategies that might work. You can ask the lender for a higher loan amount with an amount of funds held back with the lender. If that won’t work, consider starting from another route of real estate investing until you have more money. Wholesaling is an excellent way to break into the industry while padding your cash flow.
A Legal Business Entity
You’re more likely to get funding if you have a legal business structure set up beforehand. Setting up an LLC will not only protect your personal assets should something go wrong but also shows you’re a serious investor who’s taking this business seriously. Also, some lenders will deal with businesses only, leaving you with fewer options.
Consult an attorney to discuss which type of business will work for your situation. Most flippers open an LLC or S-Corp to start.
A List of Your Contractors
Some lenders will only fund repair costs that are used to pay licensed contractors. If you’re an experienced flipper who has a stellar reputation with your lender, they might give you some wiggle room. However, if you’re just starting, they’re going to want documentation of who will be doing the work and what the estimate looks like. Too many things can go wrong with amateur work that can damage the value of the home and skyrocket costs. While you might be the handiest DIYer you know, it’ll be challenging to get the money you need without professional help behind you.
What Fees Come with a Hard Money Loan?
The type and rate of fees you’ll pay depend on the lender you work with, but there are a few pretty standard costs.
An origination fee is an amount you’ll pay to cover the administrative costs that come along with servicing the loan. This can be shown as either a percentage or “points.”
Interest will be charged monthly until the loan is paid in full. The amount of your interest rate will depend on your experience, the down payment, and whatever other factors your lender uses to reduce their risk.
Some lenders will charge a fee for paying off the loan earlier than your contract states. Like any business, hard money lenders budget their costs by using projections on monthly or yearly income. If you pay off the loan early, that removes a portion of their projected income for however long is left on your contract, so they need to re-adjust their projections to accommodate that.
How Do the Top Hard Money Lenders Compare?
I’ve pulled together a list of the top hard money lenders so you can see how their current rates compare so you can decide which lender to work with. Keep in mind that some of these will vary based on their business practices, the factors listed above, etc., so it’s best to reach out and speak with each company, so you get the most competitive offer possible.
|Minimum Credit Score Required
|Amount They’ll Fund
|100%, up to $350,000
|5.5% - 6.5%
|Two successful flips or have owned two rental properties within the past 36 months
|80%, Up to $5 million
|3% - 5%
|5% if repaid within the first six months
|Up to $2 million
|1% - 5%
|5% if repaid within the first 12 months
|0-5 successful flips in 24 months
|Up to $3 million
|1.5%+ or $999+
|1.5% - 2.5%
|At least one successfully completed investment.
|Up to 90% of purchases and repairs
|Based on the individual property and borrower
|Up to $2 million
|Up to $2.5 million
|0% - 2%
|Five successful flips within the past 18 months
|Up to $10 million
|1.5% - 3%
|1 - 2 weeks
|1% - 3%
|2% - 5%
Hard money loans are fantastic resources for real estate investors to bridge the gap between the cash they have and the total amount they’ll need for a successful flip. Bookmark this guide so you’ll always know what to do before applying so that you have the best chances to be approved.
Learn how to make money flipping real estate with us by attending our next webinar.