Hard money loans: Pros, cons and when to use them

Quick insights

• A hard money loan is a short-term loan that uses your home as collateral.
• Hard money loans can be useful for real estate investors and homeowners transitioning between properties, but carry greater risk compared to traditional mortgages.
• Refinancing your current mortgage or borrowing against your home equity may be a better option for some homeowners.

If you’re a homeowner, you may see advertisements for hard money loans, private money lenders or hard money lending companies offering to loan you up to 80% of your home’s value in less than a week. While these loans can be useful in specific situations, they also carry significant risk of losing your home.

Understanding what hard money loans are, how they work and when to use them can help you avoid their drawbacks. You may also discover alternative options that better fit your situation and needs.

What is a hard money loan?

A hard money loan lets you borrow money using your home or another property as collateral. Hard money loans aren’t offered by banks or traditional lenders. Instead, you’d need to get one through a private lender or another company that specializes in these types of loans.

How do hard money loans work?

Hard money loans work differently from mortgages and other types of loans offered by banks and commercial lenders. This effects the following:

• Interest rates: Hard money loans tend to have interest rates ranging from 10%–18%, though every lender is different.ec-mrtg-calculator
• Down payment: Down payments tend to be high, commonly ranging from 20%–35%, depending on the lender.ec-experian-hard-money-loan
• Repayment period: Hard money loans tend to be short-term loans with repayment periods ranging from several months to a couple of years.ec-experian-hard-money-loan
• Monthly payments: This type of financing is usually interest only with a large payment for the remaining balance—often called a balloon payment—at the end of the repayment period.
• Borrowing limits: Most hard money loans allow you to borrow up to 80% of your home’s value, and in some cases up to 90%.ec-experian-hard-money-loan
• Approval process: These loans can be completed in a few days.

What are hard money loans used for?

Because of their short repayment period and higher interest rates compared to mortgages and other types of loans, hard money loans are often used by real estate investors who are more likely to have money available for the balloon payment once the repayment period ends. Though, some other types of borrowers may consider this type of loan as well.

Flipping properties

Hard money loans are sometimes referred to as flip loans because they can be used for flipping properties. This is the process where an investor buys a residential or commercial property with the intent to renovate and resell it at a profit.

Assuming they can resell the real estate investment before the end of the loan period, a hard money loan can make sense, since there’s minimal upfront costs and they can repay the loan with the profits from the sale.

Transitioning between homes

Hard money loans may also make sense for homeowners who need money to make a down payment on a new home before they’re able to sell their current one. A hard money loan would allow them to borrow against the existing value of their home without needing to refinance or take out a home equity loan.

They can use the money to purchase a new home and then repay the loan once they’ve sold their existing one. Some traditional lenders may offer bridge loans that can serve the same purpose with less risk. Chase does not offer bridge loans at this time.

Using equity to avoid default

In rare cases, a homeowner may find they’re in default on their mortgage even though they have significant equity in their home. This may occur because their cash flow has been affected by recent events, such as a divorce or the loss of a partner.

In these cases, a hard money loan may allow the homeowner to avoid defaulting until their financial situation improves or they can sell their house for a profit to repay the loan.

Hard money lending vs. traditional home lending

While hard money loans can be useful in specific situations, they lack the oversight and protections you’d get with a traditional mortgage loan. Traditional mortgagesec-cons-fin-keytermsec-cons-fin-keyterms:

• Have longer repayment terms of 15–30 years.
• Have clearly defined interest and repayment terms that are spelled out in advance.
• Are regulated at the federal and state level.
• Require borrowers to go through a careful income and credit review, which can take several weeks to complete.
• Include foreclosure protections for borrowers and minimizes risks for lenders.

Pros and cons of hard money loans

Before considering a hard money loan, you’ll want to weigh the pros and cons, especially compared to a traditional loan.

Pros

• Available in less time: A mortgage application usually takes a few weeks to complete, while a hard money loan can be acquired within a week.
• Able to access more home equity: A mortgage refinance may limit the amount you can borrow based on your mortgage debt, but a hard money loan may allow you to borrow more.
• Interest-only repayment: With a hard money loan, you only need to pay interest during the repayment period. This can keep monthly payments low in the short term.

Cons

• Higher interest rates: While mortgage interest rates are currently around 6%–7%, hard money loans often have interest rates starting around 10%.ec-mrtg-calculatorec-mrtg-calculator
• Balloon payment: Because hard money loans have a balloon payment, you’ll need to be able to repay the bulk of your loan when the payment comes due.
• Risk of losing your home: You could lose possession of your home if you fail to meet your hard money loan’s repayment terms.

Alternatives to hard money loans

If the risks and terms of a hard money loan don’t fit your needs, there are other ways to borrow money that you may be able to take advantage of.

Home equity loan or home equity line of credit (HELOC)

If you want to borrow against your existing equity, you could use a home equity loan or a home equity line of credit (HELOC).ec-cons-fin-keytermsec-cons-fin-keytermsec-cons-fin-keyterms These options allow you to borrow against your available home equity and repay the loan over a predetermined period of time.

Cash-out refinance

Another way to access your home equity is by using a cash-out refinanceec-refinance-hl000061ec-refinance-hl000061ec-refinance-hl000061ec-refinance-hl000061, which lets you refinance your current mortgage and borrow against the available equity. You may even be able to get a more favorable interest rate or longer repayment term.

Small business line of credit

If you’re looking to borrow money to buy an investment property and are registered as a small business, you may be able to talk to your lender about a small business line of credit. This is money you can draw on as needed, up to a limit set by your lender.

In summary

A hard money loan can serve as a short-term solution for borrowers who are looking to buy an investment property or need to borrow money against their home for a brief period of time. However, it does come with risks. Seeking out a tax and real estate professional for advice could be a beneficial next step.

If you’re looking for less risky ways to borrow against your home’s available equity, talk with a home lending advisor today.