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In competitive real estate markets, speed is a highly valuable asset. Waiting 30 to 50 days for a traditional bank loan to close on an investment property mortgage could cause you to lose out on a deal.

Private and hard money loans can provide the expedited financing you need. Let’s look at how these loans work, when they make sense, and what alternatives exist.

A hard money loan is a short-term financing option commonly issued by private companies. It is typically secured by real estate as collateral. Rather than the borrower’s credit score or income, approval is often based primarily on the property’s value.

Hard money loans are designed for situations where traditional financing isn’t available or isn’t fast enough.

Private money loans cover a wider range. Usually more relationship-driven, private loans can originate from almost anyone beyond the established lending world. Funds could come from a private individual, an investment group, or a family-owned lending company.

As private money loans fall outside standardized financing, their terms and structures tend to be more flexible than those of hard money loans.

Both loan types differ from conventional mortgages in several key ways:

• Approval: Conventional mortgages often require income verification and credit checks; approvals for hard money and private loans are typically asset-based.
• Timing: Conventional mortgages can take between 30 and 50 days to fund; hard money and private loans can often be funded in as little as 10 business days.
• Structure: Conventional mortgages often have longer terms, lower interest rates, and greater consumer protections.

The approval and amount of hard money and private money loans are primarily based on the value of the property. For renovation projects, mortgage professionals typically consider the After-Repair Value (ARV) – the property’s estimated value after the work is complete.

Loan amounts commonly fall between 60% and 75% of the property’s value. This leaves an equity cushion of 25% to 40% in the asset you are leveraging.

Here’s what the terms generally look like for hard money and private money loans:

• Interest rates: 10% to 18%.
• Down payment: 25% to 40% of the purchase price.
• Loan term: 6 to 36 months, often on the shorter end.
• Closing timeline: Often within 10 business days.
• Fees: Origination fees can be significantly higher than conventional loans.
• Repayment structure: Interest-only monthly payments, with the entire principal due as a balloon payment at the end.

The balloon payment merits extra emphasis. With a hard money loan, the principal does not decrease each month as it does with a traditional mortgage. You need a solid plan to pay off the balance in a lump sum at the end of the term. Most borrowers pay off the principal by selling the property or *refinancing into a traditional loan.

Pros:

• Speed: You can often secure funding in days. This can rival the purchasing power of all-cash buyers, making the difference between winning and losing a deal.
• Flexibility: With the approval focused on the collateral property, credit blemishes and past financial issues are usually not automatic disqualifiers.
• Equity access: A property’s value can unlock borrowing power typically not available with a conventional loan.
• Versatility: These loans cover a range of real estate scenarios, such as fix-and-flips, bridge financing, urgent repairs, and distressed property purchases.

Cons:

• The cost: Interest rates can be substantially higher than conventional mortgages. Upfront origination fees (points) require significant cash at closing.
• Short repayment window: Most loans span 6 to 18 months. That leaves little room for error should you experience a construction delay or a sudden market dip.
• Balloon payment risk: Failure to repay the loan at the term’s end could put your property at risk of foreclosure if you don’t refinance or sell the property.
• Reduced safeguards: Borrowers have fewer consumer protections compared to a federally regulated mortgage.
• Property restrictions: These loans are typically not for owner-occupied homes.

These loans tend to make sense when:

• Flipping: When you have a clear timeline from renovation to selling before the loan comes due.
• Closing fast: When you are in a competitive market or have a time-sensitive deal.
• Distressed properties: When you can’t get a conventional loan due to the property’s poor condition.
• Bridge financing: When you need a loan to bridge the gap between buying a new property and selling your current one.
• Fast cash: When you need urgent cash for another business opportunity.

These loans tend not to make sense when:

• Homebuying: When you’re a first-time buyer purchasing a primary home, a conventional mortgage is typically a better fit.
• Exceptional credit: When you can qualify for traditional financing with lower borrowing costs.
• Lack an exit strategy: When you don’t have a realistic plan for repaying the balloon payment through a timely sale or refinancing.

Several options have lower costs and can be as effective as private money and hard money loans.

• DSCR (Debt Service Coverage Ratio) Loan: This allows you to qualify based on the projected cash flow generated by the property you are buying.
• No-Income Loan: This offers qualification based on your credit and asset strength.
• Home Equity Line of Credit (HELOC): This lets you borrow against your equity, drawing cash in stages as needed, typically at lower rates with longer repayment terms.
• Home Equity Loan (HELOAN): This allows you to borrow similar to a HELOC, but receive the money in a lump sum.
• Cash-Out Refinancing: This replaces your current mortgage with a larger one, giving you the difference in cash, possibly improving your rate or terms in the process.

*Refinancing Disclaimer: When it comes to refinancing your home loan, you can generally reduce your monthly payment amount. However, your total finance charges may be greater over the life of your loan.