When traditional lending sources are not an option, some individuals turn to hard money loans for alternative sources of funding. These types of loans are not usually the first source of funding individuals attempt to secure, but there are some situations in which a hard money loan makes good financial sense. What is a hard money loan, and what situations make this kind of funding source the best option for a business or property owner?
Hard Money Loan Overview
In contrast to traditional bank loans that decide to lend money based on credit scores, debt-to-income ratio and other factors that determine risk, hard money lenders provide funds based on collateral. Typically, the collateral that is used for this type of loan is the property or business the individual plans to use the money to create or purchase.
Benefits of Hard Money Loans
The primary benefit of a hard money loan over a traditional loan is turnaround time. This can be advantageous if you need funds quickly and do not have time for the long wait of the underwriting process involved with a traditional loan. Another advantage is for those who don’t want to have to worry about proving financial ability to repay. Since their property is being used for collateral, a hard money loan default just results in forfeiting the collateral property. Hard money lending terms also tend to be more flexible than traditional loans, which is another advantage to this source of funding.
The Downsides of a Hard Money Loan
Since hard money loans are easier and faster to obtain, why are they not automatically the preferred lending method? Typically, these loans are short-term loans only and are rarely lasting longer than five years. Rates and fees are typically much higher than with bank loans, making payments more expensive. Some individuals are uncomfortable with the idea of putting up their investment property or business as collateral, so they choose to try to secure funding elsewhere.
If you are a fix-and-flip investor or if your business is a startup that needs fast funding to get off the ground, a hard money loan can be a quick way to secure funding without worrying about meeting strict financial requirements or lengthy underwriting processes. There are both benefits and downsides to hard money loans, so learning all of the details about the process can help you decide if applying for one would be beneficial to your particular situation.