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How Does a Hard Money Loan Work?

Have you ever asked, “how does a hard money loan work?” Hard money loans are typically used for specific real estate purposes. Because of this, they work a little bit differently than traditional bank loans. They are called hard money loans because they are backed by the value of a “hard” asset, rather than the credit and income of the borrower.

Why does that make a difference?

The structure of a hard money loan has two big distinctions. For purchasing a real estate property, the traditional bank loan process is stringent and lengthy. Hard money lenders are private individuals or companies (like Park Place Finance), so their time-to-approval is much quicker. For borrowers buying a property with the intent of renovating and flipping it, the time-consuming traditional process eats into their potential for profit.

The other major differentiator is that the loan is backed by the asset. For borrowers that don’t meet a bank’s strict credit demands, a loan based upon the value of the property instead is a major boon.

woman-holding-small-house-and-money-and-keys

How Does a Hard Money Loan Work?

Hard money loans operate similarly to traditional loans. The bottom line is that both loans have specific purposes. It’s the nuances between them that make all the difference.

For instance, I mentioned earlier that a key difference between hard money and traditional mortgage loans is that the hard money loan is backed by the asset rather than the lender’s credit and income.

This is important because a hard money lender can assess a property that a borrower is interested in purchasing by considering its after-repair value (ARV). If an individual wants to purchase a $200k home to live in for 15 years, a bank will give them a loan for the purchase price.

However, if an individual wants to purchase a $150k property that needs a lot of renovation and estimates its ARV at $300k, then a hard money lender can loan out much more than the $150k for the initial purchase. This additional cash partially or completely funds the real estate investor’s renovation costs.

Applying for a Hard Money Loan

To begin, the borrower will have to apply for the loan through a private hard money lender. However, the benefit of choosing a hard money lender begins to kick in here because the borrower doesn’t have to endure a lengthy underwriting process.

After submitting a loan application, a private lender has more flexibility in the loan terms they can provide. Traditional banks are bound by many regulations and therefore only able to offer unyielding terms, rates, and timelines.

Private hard money lenders don’t have to stick to the same rigidity, providing their clients much more freedom. This flexibility can be helpful for house flippers with irregular expense and income timelines for their project.

Duration of a Hard Money Loan

The duration of a hard money loan is much shorter than a traditional mortgage. Often only 12 months compared to a traditional mortgage which is typically thirty years.

You might be thinking, “Why would I want such a short loan timeline?”

For many people purchasing a home they plan on living in for the next 15-20 years, a traditional mortgage with a 15- or 30-year term certainly makes sense. However, house flippers and other real estate investors are purchasing a property to resell or refinance quickly. Having a lender that accommodates their expedited timeline is much more beneficial.

The large upfront cash infusion allows for house flippers to finish renovating a property, sell it, and pay off the rest of the loan immediately. Then, they can move on to their next project. This way, the borrower doesn’t need to have as much of their own cash on hand to fund their project.

Who Needs a Hard Money Loan?

These loans are beneficial in many different situations. They are especially beneficial for those who need to close real estate deals quickly.

Consider a hard money loan for any of the following purposes:

  • Real estate investor purchasing 1-4 unit properties
  • Fix-n-flip
  • Borrower wanting to access the equity in an already-owned property
  • Cash-out finance

Do You Need a Hard Money Loan?

Hopefully, this has answered that “How does a hard money loan work” question for you. If you are a real estate investor or looking to become one, consider using a hard money loan from Park Place Finance for your next real estate deal. Close quickly and begin your project without starting capital holding you back.

Justin Hubbert

Justin began his lending career working for a Lending Tree Affiliate and Chase Bank for several years before opening Park Place Finance in Austin, Texas in 2007. With expertise in condo project approvals, working with self-employed borrowers, and Texas Cash Out loan regulations, he has originated over $110 million in Conventional, FHA, and jumbo residential loans.

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