What are hard money loans?
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Written by
Sara Routhier
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Reviewed by
Joel Ohman
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UPDATED: May 22, 2012
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Hard money loans are a type of personal loan that are secured by a borrower’s real estate. This type of financing is usually originated only by private investors who specialize in issuing hard money loans, and are almost never available through traditional lenders.
These property-backed agreements are issued to virtually anybody interested in them, so long as they have adequate equity in a property to secure money. As a result, bad credit borrowers often find hard money loans to be valuable sources of financing.
Since hard money loans are issued to borrowers regardless of their financial backgrounds, they come with high interest rates. Usually ranging between 10 and 20 percent, these are not the most ideal financial arrangements.
Furthermore, they often require upfront fees in the form of “points.” Points equate to 1 percent of the entire principal of a loan, and hard money loans typically call for at least 2 points. If a borrower is seeking $50,000, for instance, he can expect to pay at least $1,000 in points—or 2 percent of the loan’s principal.
In the unfortunate event a borrower defaults on his hard money loan, he will be at risk of losing his collateralized property.
Due to these unfavorable conditions, they’re often referred to as the personal loans of last resort.
Because hard money loans are secured by real estate, borrowers must have equity in their property if they hope to be approved for this type of financing. The equity required is somewhat of a rarity in today’s real estate market since borrowers are usually expected to have a loan-to-value (LTV) ratio of at most 65 percent. That means the remaining balance on a borrower’s mortgage must not be greater than 65 percent of the property’s appraised value.
For example, on a home worth $200,000, a borrower must owe less than $130,000 on it.
The reason why that’s a rarity today is because of the real estate collapse that occurred in 2008. With the housing bubble’s explosion, millions of homeowners’ LTV ratios shot up to 100, 200, 300 percent or more. When LTV’s exceed 100 percent, homeowners lose all equity in their property, and instead are said to be “upside-down” or “underwater.”