What Is a Hard Money Loan and How Do You Find One?

Financing investment properties isn't always easy. If you're trying to buy a home for a fix-and-flip project, acquire a commercial property, or buy a rental property that is in need of extensive repairs, a traditional mortgage might not be possible.

One alternative is to use a hard money loan, which is a special type of financing that is often used by real estate investors with short-term capital needs. Here's a rundown of what a hard money loan is, what they can be most useful for, and where to look for hard money financing for your project.

What is a hard money loan?

A hard money loan is a type of real estate loan that is typically short-term in nature and doesn't come from a traditional mortgage lender. In most cases, hard money loans are made by private investors or companies, and are made for the purpose of short-term real estate financing needs.

Hard money loans generally have significantly higher interest rates and fees than traditional mortgages. Interest rates well into the double digits are quite common. On the other hand, hard money loans have more flexible qualifications than other types of financing, and can typically be originated in days, not weeks or months as is the case with traditional financing.

Unlike traditional mortgages and most other types of loans, hard money loans are usually based on the value of the property you're buying, or the after-repaired value (ARV) of a real estate project. To be sure, you may need to agree to a credit check, but hard money loans are generally based on the assets, not the borrower's qualifications.

Hard money loans are also different from traditional mortgages in that they are rarely made with borrowing terms in excess of a few years. For example, you might obtain a hard money loan with a 1-year term for the purpose of buying a dilapidated home and renovating it to sell at a profit.

Is a hard money loan right for you?

As mentioned, hard money loans tend to have shorter terms than conventional mortgages, and also typically come with high interest rates and fees. Therefore, they typically aren't the best option in cases where you want to buy a rental property and simply hold it for the long term.

With that in mind, there are some situations where using hard money loans can make sense:

• Fix-and-flip financing: This is by far the number one use case where hard money loans make sense. It can be extremely difficult to finance a house flip through traditional means, and the short-term nature of these projects makes them excellent candidates for hard money loans.
• You plan to eventually get long-term financing: Some properties aren't eligible for conventional financing in their current condition. For example, if you plan to buy an uninhabitable property, do a full renovation, and then rent it out, it can make sense to obtain a hard money loan with the intention of obtaining other financing and paying it off before the term expires.
• If time is a big factor: One of the big advantages of hard money loans is that they can be closed fast. So, they can potentially make sense if you have to close quickly for whatever reason.

In a nutshell, hard money loans are best suited for situations where you need the money for a relatively short period of time (say, a year or two at most), you have a clear exit strategy, and the numbers still work out in your favor.

Alternatives to hard money loans

A hard money loan is one option for financing investment properties, but as we saw in the previous section, it isn't right for all situations and can be a costly way to borrow. So, before you decide to apply for a hard money loan, there are some other forms of financing you might want to consider first.

Traditional mortgages

One thing new real estate investors often don't understand is that you can use a conventional mortgage to buy an investment property. You'll need to qualify with your credit and income, but you may even be able to count some of the property's expected rent as income. If you can qualify, a conventional mortgage is typically the most economical way to finance an investment property.

There are also long-term mortgages offered by lenders who don't consider your personal income (known as asset-based loans). Before using a hard money loan to finance an investment property, it's usually worth looking into what traditional mortgage options are available.

HELOCs

If you have significant equity -- either in your primary home or another investment property -- you may be able to use that equity to finance your next project.

A home equity line of credit (HELOC) gives you a credit line that is backed by the equity in your home, and you can choose to use as much or as little as you need. There are also home equity loans, which are also referred to as second mortgages and are fixed-amount and fixed-term loans.

Personal loans

There have never been more lenders willing to make unsecured personal loans not based on any particular asset, and these often have better terms than you're likely to find with a hard money loan. One big caveat is that some (but not all) personal loans specifically exclude real estate from an allowable use of the loan proceeds, so you may need to do some shopping around to find one suitable for a real estate project.

Compare various loan features as the apply to each type of financing:

How to find hard money lenders

Since hard money loans are typically made by individual investors or private companies, it isn't as easy as simply finding a list of the top hard money lenders. Some only lend for specific purposes, such as fix-and-flip projects, and some only lend in certain locations. Plus, many don't call themselves hard money lenders -- they use terms like "private direct lenders," "relationship lenders," and more.

With that in mind, one strategy is to join some real estate investing groups on social media or in your local area, or to simply search for "hard money lenders in (your state)." If your real estate agent has lots of experience with investment properties, they can also be a great source.