Definition
A hard money loan is a short-term, high-interest loan secured by real estate, typically used by real estate investors, house flippers, or borrowers who don’t qualify for traditional financing. These loans are issued by private lenders or investment groups rather than banks and have faster approval times but come with higher interest rates.
Explanation
Unlike conventional mortgages, which focus on a borrower’s creditworthiness and income, hard money loans are primarily based on the value of the property being used as collateral. This makes them a popular option for:
- House flippers who need quick financing to purchase and renovate a property before selling.
- Investors who buy distressed properties at auctions and need immediate capital.
- Buyers with poor credit who are unable to qualify for traditional loans.
Hard money loans typically:
- Have short repayment terms (6 months to 3 years).
- Charge higher interest rates (often 8% to 15%).
- Require a large down payment or equity stake (usually 25%-40%).
Since hard money lenders take on more risk, they may charge origination fees, points, and prepayment penalties. Borrowers must have a clear exit strategy, such as selling the property or refinancing with a conventional loan before the loan term ends.
Example
An investor finds a fixer-upper property priced at $250,000 but needs fast funding to secure the deal. Instead of waiting for a traditional mortgage approval, they obtain a hard money loan covering $200,000, with an interest rate of 12% for one year. The investor renovates the property, sells it for $400,000, repays the loan, and pockets the profit.