Financial institutions are traditionally the basic lenders to real estate investors. However, recent lending regulations have tightened the terms of engagement, leading investors to look elsewhere. While ordinary lenders ask for too much collateral, some eligible investors have such poor credit scores that they cannot please banks.
This leaves hard money lenders as the best alternative for real estate investors. Perhaps the biggest advantage of alternative lenders is that you can qualify for real estate financing with a poor credit score. The other obvious advantages are the speed of financing and the flexible (and often negotiable) repayment terms.
Are there some disadvantages of borrowing from hard money lenders? Yes. It is prudent to know the other side of any real estate investment option before you sink both feet in. The following are the most basic hard money lending drawbacks that you need to consider.
You will usually need a larger down payment
Most hard money lenders will ask you to make a down payment of the required loan amount. This means that you will have to dig deeper in your pockets when you choose this option over traditional financing. 25-30% is the common range of down payments. If you do not have the required down payment, the hard money lender may require to have a 25-30% equity in your investment.
This requirement is so tough because of the huge risks that the lender takes. If the real estate property was to undergo bankruptcy, foreclosure or short sales, the lender has some collateral to cling to. If something went wrong with the property, the hard money lender is left in trouble especially where a borrower has no equity in the investment.
This is not always the case though. In fact, some hard money lenders will finance an entire investment, allowing you to put 0% down. These are often called 100% LTV loans.
The interest rates are often higher
Perhaps the biggest disadvantage of borrowing from hard money lenders is the high interest rates involved. These lenders impose higher rates than banks, credit unions and other conventional lenders. Repayment terms often range between 8-15% of the loan amount.
These interest rates are high just as the risks of funding a real estate project are high. The lender is never assured that the seemingly lucrative investment will actually break even. Another risk that pushes interest rates high is the fact that lenders do not require the borrowers credit score, financial history and gross domestic income.
Most hard money loans are short-term
Most hard money lenders will only write loans for up to 2-3 years. As they cannot predict the long-term future, they need to recoup their money back while the foreseeable financial conditions in the real estate investment prevail. Lenders simply do not shoot in the dark as far as real estate returns are concerned.
The shorter the loan term, the lower the uncertainty of lenders as to where interest rates will go. Other factors that limit the loan terms are loose regulation, stricter legislation, unpredictable government policy and unstable fortunes in the real estate industry.
Conclusion
Hard money lenders may have their fair share of negative reputation. But even with these disadvantages, the benefits of borrowing loans from them still carry more weight than the drawbacks. Hard money lenders are still the alternative financiers of real estate where conventional lenders have developed cold feet.
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