Hard money offers quite a few selling points for investors. One is speed. Another is easy to understand terms. The combination of both makes hard money quite attractive to investors looking to obtain new properties without having to jump through all the hoops normally associated with conventional financing.
In terms of speed, Salt Lake City’s Actium Partners says it rarely takes more than a couple of days to arrange a hard money loan. Investors could never get that kind of speed from a bank. Where terms are concerned, hard money lenders tend to keep things simple. Simple terms make it easier for borrowers to always know where they stand.
Table of Contents
Short Term Loans
Hard money loans are short term loans by design. How short? A typical loan has a term of 6-24 months. On rare occasions, a lender may agree to 36 months, but that’s about it. You will never find a hard money loan with a 30-year term.
Short terms are advantageous to lenders because they do not have to tie up their money for long periods of time. But it turns out they are equally advantageous to borrowers. Provided a borrower has a proper exit plan, short terms allow him to get his money out quickly so that it can be put into other investments.
Interest Only Loans
Hard money loans are usually designed as interest-only loans, so that’s something else to take into account. This implies that the sole amount paid each month is interest. Throughout the term, no principle is paid. Only a balloon payment is made for it at the end of the term.
A similar type of loan in the residential mortgage market is the balloon mortgage. Over the life of the loan, the homeowner only makes interest payments from month-to-month. The principal borrowed – let us just say it’s $100k – is due with the final monthly payment.
Balloon mortgages were pretty popular throughout the 1990s and into the early 2000s. They were popular in the sense that they allowed people who could not truly afford to buy homes to do so anyway. But as we know from the 2007/2008 housing crash, balloon mortgages are terribly risky.
Hard money loans structured as interest only loans are equally risky. However, lenders protect themselves with higher interest rates, shorter terms, lower LTVs, and collateral requirements.
Lower Loan-to-Value (LTV) Ratios
A lower LTV helps protect the lender by requiring a borrower to put up more cash as a down payment. The lower the LTV, the less the lender risks as a percentage of the property’s total value. Should a borrower default, the lower LTV makes it easier for the lender to recover all its money.
The Exit Strategy Is Critical
A combination of short terms and interest only payments make an investor’s exit plan critical to his success. He needs to have a viable way to pay what he owes at the end of the term, or he risks losing the property. Exit strategy is so important that it can make or break a loan application.
Simple to Understand and Execute
Having a handle on hard money terms makes it clear that hard money loans are both simple to understand and execute. One doesn’t need to be a financial expert to understand short terms and interest only payments.
By keeping things simple, lenders can more effectively do what they do. Borrowers always know where they stand, and loans are executed without much trouble. Simplicity is yet another reason property investors tend to prefer hard money in bridge loans over conventional financing. Simplicity is attractive. It is just that simple.
