The Risks and Rewards of “Hard Money”
Living in California, you may have heard something about “hard money” loans, which have become popular thanks to the state’s enormous real estate market. The more formal (though interchangeable) term for hard money loans is private money loans, and, broadly, the concept refers to loans guaranteed by real, physical property.
Generally, private money loans are used outside the traditional banking and financial institution system to facilitate short-term real estate deals, typically using property as collateral. In fact, banks almost never participate in private money loans, meaning the terms are negotiated on a case-by-case basis between the borrower and lender. It has become popular in California due to its frequent usage to manage “property flipping,” the practice of acquiring, renovating, and reselling real estate, often in short periods of time.
While there are a number of possible benefits to private money loans, they can also carry plenty of risks. We break down the advantages and disadvantages below.
Potential Benefits of Hard Money Loans
It can take a substantial amount of time to secure a more traditional loan, such as a mortgage, through a bank or other financial institution. This is in part because institutional lenders perform due diligence on their potential borrowers, since they want to make sure they will be able to repay the loan. This process can require time-consuming credit checks and an investigation of credit history.
Because private money loans avoid involving banks, lenders are not typically beholden to the same standards in vetting borrowers. Thus, the process of negotiating and securing a private money loan can often take significantly less time, days or weeks instead of months, compared to other types of loans.
Since hard money loans are “private,” there can also be opportunities for more flexibility. The lack of a standard underwriting process gives both borrower and lender room to negotiate terms specific to their situation. For example, a borrower might request additional repayment opportunities within the established loan window, an option not available when dealing with a traditional bank maintaining rigid requirements.
Potential Downsides of Hard Money Loans
A typical mortgage usually carries a loan-to-value (LTV) ratio of around 80%, but private money loans skew much lower, often with an LTV range of 50% to 70%. This means the risk of default on a private money loan is considered to be substantially greater, in large part because the collateral property is the only protection against that worst-case scenario. This is not necessarily a deterrent to lenders, who are likely interested in the underwritten property and see a potential upside regardless of whether the borrower repays.
Interest rates for private money loans are also significantly higher than other loan categories, ranging anywhere from 7.5% to 15% based on the length of the loan. Compare that to the prime interest rate of 5.25%.
Finally, be aware that some lenders will not pursue hard money loans underwritten by occupied property, such as a house the aspiring borrower is currently living in. There is additional regulation and oversight governing the financing of such properties that can limit the efficiency that makes private money loans attractive in the first place.
Do Not Go It Alone – Let an Experienced Attorney Help
If you are considering undertaking a hard money loan or are in the process of managing one, we at McFarlin LLP can help. Our experienced attorneys have handled over 500 “high-stakes” real estate cases throughout California with a 96% successful settlement rate.
If you are wondering if a private money loan makes sense for your situation, we may be able to give you the guidance you need. Call (949) 570-5025 or contact us online for a free case evaluation.