A hard money loan is a quick way for an investor to get the necessary funds for their project. That being said, hard money loans still cause some concerns in the investor community. There are still some questions that are being raised regarding if hard money loans are better compared to traditional ones. Basically, a hard money loan is a type of loan that is provided by a company or a private investor. They are short-term loans which use the provided asset as collateral. Usually, these loans are most popular amongst investors that work in real estate. They are great for fast fix and flip projects, as well as purchases for commercial real estate. What makes them stand out is the fact that you can get them much faster and easier compared to traditional loans. So if you need money fast for a project, a hard money loan might not seem like a bad idea.
The Risk Factor
Like any other loan, there are certain risks that come with it. As for the hard money loans, there are risks for both sides. The lender, and you as a borrower, will have to take on risks. What this means is that you as a borrower do not have to meet as many requirements as you would have to for a traditional loan. On the other hand, because of the lenient requirements, a borrower will take on much more risk when they provide you with a loan. As we said, these loans get processed fast so the lender does not have a lot of time before the deal is closed. Because of that, the property in question is used as collateral. This way, a lender can, to some extent, reduce the risk they take for themselves. Additionally, hard money loans have a higher interest rate in general.
With these higher interest rates, borrowers put a lot of risk on themselves by paying more for the loan and the costs in the end. This can prove to be a big problem for them as they can easily lose the property or asset they have if they are unable to pay off the loan. That being said, this does not mean that it is all risk. There are ways for both sides to reduce the risk factor. We will try to cover everything that you should know about the risks, how to reduce them, and how everything works. Here is some advice that can help you.
Hard Money Loan Risks
As we already mentioned, one of the main risks of a hard money loan is the high-interest rates. The reason behind this is that these loans are given for a shorter period and because of that the lenders had to reduce the risk in some way. The interest rates usually range from 10% to 15%. Additionally, the shorter repayment period can prove troublesome as the borrower does not have as much time to pay it off. The repayment period for a hard money loan can go between 6 to 18 months. A borrower must be sure that they can make the monthly payments in time in such a short time. If they cannot, then they could lose the asset completely. This short period is definitely a huge risk factor for the borrower.
The next risk factor we will cover is the higher costs. A borrower has to pay higher origination fees as well as higher closing costs. Furthermore, some hard money lenders ask for down payments that can even go up to 30%. Some of the costs that a borrower will need to pay are referral fees, processing, the down payment, underwriting points, document preparation fees and more. An additional risk you need to consider is the LTV. A loan-to-value ratio, or LTV for short, is the comparison of the loan size regarding the value of a property or asset that the borrower will buy with the loan. The LTV that can be expected is anywhere between 70% and 90%. When it comes to the after-repair value, the hard money loan will usually only cover up to a maximum of 70%. The rest falls on the borrower to cover.
How to Reduce Risks
There are several ways that a borrower can reduce the risks. First and foremost, always analyze the deal. Analyze every detail from ARV, LTV, cash flow, is the asset in a good location, and the return on investment. Additionally, always look for an experienced hard money lender that has a good reputation. Furthermore, make sure that there are no so-called hidden costs. It is crucial that you are aware of these costs so that you know you can cover them when the time comes. Lastly, know your budget. Knowing how much money you can spend and if you can even get a hard money loan is the most important thing. Make sure that you can repay everything on time before you take out a loan.
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