The Pros and Cons of Using Hard Money Loans for Investment Properties

Using hard money loans to fund property investments is fast becoming one of the prime methods of raising cash—both for the solo entrepreneur and individuals, investment groups, and businesses with more experience. With more and more people dipping their toes in the world of bricks and mortar, financing the deal through non-traditional lending is now a popular option. 

Of course, such borrowing has its advantages and disadvantages. Being aware of what these are is key to deciding whether this is the correct route to take.

Hard Money Loans: The Good, the Bad, and the Ugly

• What is a hard money loan?
• The advantages of hard money loans
• The disadvantages of hard money loans

What is a hard money loan?

Hard money lending is provided through private equity—typically investors or high-worth individuals—that secures the loan on an asset, rather than the borrower’s net worth, income, or credit rating. In the case of property investment, the building provides the collateral. Both companies and individuals can access a hard money loan.

This type of borrowing is generally short-term, perhaps over months or a maximum of two to three years. The exact term will be determined before the loan is actioned. For an investment property, this would cover the period it would take to buy a distressed property, carry out the necessary renovations, and then sell or rent it before paying back the outstanding loan (plus a bit of leeway to account for the inevitable delays that occur along the way). During this time, monthly payments are made to cover the interest.

The amount that can be borrowed will be based on the estimated value after the rehab is complete. A typical maximum amount lent would be 75% of this or up to 90% of the original purchase price. 

The advantages of hard money loans

There are many advantages of taking out a hard money loan over more traditional, usually bank-funded borrowing. They include:

• The timescale in which you can secure the funds: While traditional lending might take several weeks or even months, a hard money loan can usually be processed within a week or so—or even days. This can be extremely beneficial, especially in scenarios where the cash needs to be accessed very quickly to secure a deal. Examples include buying a property at auction or one that has been or is imminently subjected to foreclosure. 
• Flexible terms: Hard money lenders don’t have to adhere to the same regulations as mainstream lenders. This means that the terms can be adapted to suit a wider range of borrower circumstances.
• A high credit score isn’t a prerequisite for approval: This is because the loan is secured on the asset (the property) rather than the individual’s or company’s financial circumstances. Those who have a poor credit score—or are, perhaps, maxed out with more traditional credit—often find that a hard money loan is the key to starting or expanding a property portfolio. However, while such lenders aren’t beholden to the same regulations as banks and mortgage providers, they are governed by other stringent federal and state laws to ensure responsible lending. 

The disadvantages of hard money loans

Naturally, it’s necessary to look at the flip side—AKA, the disadvantages of hard money loans—to fund an investment property. These can be summed up as:

• Higher interest rates: Because they aren’t bound by regular lending regulations, hard money loans generally represent a higher risk. Because of this, the interest rates are typically higher than can be achieved through borrowing from a bank or mainstream mortgage provider.
• Loans are only available for a short period: This is typically months but can be as much as two or three years in certain cases. A regular mortgage is usually over a far longer timescale, with anything up to 30 or even 40-year terms available.
• A higher down payment is needed: When using a hard money loan for an investment property, the borrower will need to put a minimum of 25% (often more) into the equation. How much will be factored into the lending decision. This is extremely different from a traditional property loan, which might only require the borrower to stump up as little as 3% of the purchase cost.

Traditional vs. Non-Traditional Lending for Investment Property

• When to consider a hard money loan for investment property
• When traditional lending might be more suitable for investment property

When to consider a hard money loan for investment property

Anyone thinking about taking a hard money loan to fund an investment property should be sure to understand both the pros and cons. While the lure of fast cash and less stringent borrower requirements can be tempting, it’s vital to understand the risks involved.

A failure to make the monthly payments will result in losing the entire property—and that includes the substantial 25%+ that’s been invested outside of the loan. It will also result in major credit score harm—something that then remains on record for a minimum of seven years.

However, for those who are happy with the degree of risk and have the upfront liquid cash, then a hard money loan can be an excellent method of funding an investment property. Common real estate purchases that fall into these categories include:

• Fix & flip properties: This is the purchase of distressed real estate with the sole intention of renovating it and selling it for a profit. The level of work needed can range from merely some internal cosmetics to a complete structural rebuild, the costs of which will be factored into the loan.
• BRRRR properties: BRRRR stands for Buy, Rehab, Rent, Refinance, Repeat. Although this model also involves purchasing a run-down property and doing it up, when the work is finished the home is then rented out, thus providing a monthly income. The loan is then refinanced and the outstanding is paid back to the lender. This blueprint is popular with those looking to build a property portfolio that provides ongoing revenue and, over time, increases the owner’s net worth.
• Investors with a less-than-perfect credit rating: This isn’t necessarily due to past defaults. It often applies to those who already have substantial debt through traditional lenders, perhaps for their main residence, which makes them ineligible for further bank/mainstream borrowing. Because a hard money loan uses the investment property as collateral, the existing debt isn’t taken into as much consideration. Other circumstances can also affect an individual’s ability to borrow money. This includes being self-employed, having a recent divorce, or having taken time out from paid employment. In such circumstances, hard money lending might be the only borrowing option available.

When traditional lending might be more suitable for investment property

On a purely financial basis, the greatest downside of a hard money loan is the significantly higher interest rates available when compared to traditional property lending. This means that, in some cases, a regular loan might be a preferable method of funding an investment.

Examples of this include:

• An individual with an excellent credit rating: In this case, it might be possible to secure a more traditional loan with a lower interest rate that has zero or minimal charges for early repayment. 
• Those with significant assets: Those who have a large amount of equity in their prime residence might seek to release this to fund an investment property.
• Other forms of lending: Such as vendor financing, where the person selling the property fronts the loan, and repayments/interest are paid to them while the rehab is carried out. The outstanding amount is paid off when the property is sold. Other options include loans from friends or family and home equity loans.

Taking out a hard money loan for an investment property can be an effective way for both novice and experienced investors to build and expand their real estate repertoire. However, it’s important for potential borrowers to fully understand the very different lending criteria compared to mainstream lending. 

There are many (many!) hard money lenders out there, each of which has unique terms and conditions. As with every industry, there are good lenders, not-so-good, and downright bad ones. Finding and partnering with the best is key to gaining the ultimate benefits—and highest profit—from every real estate investment. Borrowing rates can vary wildly between lenders, as can the terms and length of the loan. 

This makes it critical to connect with a reputable hard money lender—and to be fully aware of the finer details before signing on the dotted line. It’s highly recommended for borrowers to gain professional advice before committing to any such loan. Although they might not be suitable for everyone, the right hard money borrowing can be the key to starting and building healthy and profitable real estate wealth.

Exploring Hard Money Loans for Investment Property? Contact BRRRR Loans Today

BRRR Loans is a leading provider of finance to property investors. Our range of loans suit every level—from the first-time investor to those looking to build on an already substantial portfolio.

With some of the fastest closing times and lowest interest rates in the industry, it’s no wonder we’re fast becoming the financier of choice for those in the know.

Discover more at https://www.brrrr.com/ and call today for a confidential discussion.