Hard money loans may not be difficult to get, but they can be expensive. Despite the cost, they’re an essential tool for investors. Knowing when to use hard money and how to get it is critical.

Here’s everything you need to know about using hard money loans for real estate.

What is a hard money loan?

Hard money loans use real assets as collateral instead of relying on the borrower’s financial history. Typically the property you’re buying is used as collateral, but other examples include retirement accounts or other real estate properties you own.

A hard money loan is a way to borrow money without jumping through the hoops of traditional lenders. It often has more flexible terms than loans provided by the banks because private lenders offer it.

How does a hard money loan work?

As opposed to a traditional lender, a hard money lender is much more interested in the asset than the borrower borrowing against that asset. And thus, as you might expect, a hard money loan is usually quite a bit more expensive than a standard bank loan.

Banks normally have very strict and arduous criteria for conventional mortgages, especially mortgages on an investment property. This is particularly true once you’ve acquired over 10 properties in your name and are no longer eligible for a Fannie Mae–backed loan.

When it comes to owner-occupied properties, the type of loan that banks are interested in is of the cookie-cutter variety. Most real estate investors don’t make money with cookie-cutter properties, though, so hard money can be extremely useful.

While most hard money is lent out for investment property and residential property, hard money lenders can do loans on multifamily apartments, commercial office buildings, industrial property, retail, and even on items that aren’t a real estate investment, such as equipment purchases.

At first glance, hard money and private money loans appear to be the same, but they are quite different.

Hard money lenders are effectively brokers for short-term loans, mostly on real estate.

Private lenders, on the other hand, can be just about anyone who has money. A private loan is relationship-based; the lender could be a private company or even a friend or family member.

Many investors use hard money as an integral part of their financing strategy—particularly those who need loans to fix and flip. It’s a great tool to get money quickly if you know how to utilize it in the right way.

Pros and cons of a hard money loan

Given that hard money lenders are more expensive than banks, it makes more sense to go that route if you can get a bank loan upfront. Traditional purchases or properties that don’t need much rehab are not the best candidates for hard money loans.

On the other hand, properties that you intend to flip or need substantial rehab are good candidates. This is particularly true if you have some hiccups on your credit report or don’t have a W-2 income.

Banks are obsessed with W-2 income. While many will lend to full-time real estate investors, many will not—at least not to anyone without a long, proven track record, which newer investors obviously don’t have yet.

The pros and cons of hard money loans depend on your situation, but let’s go through them.

Some of the biggest perks of using hard money loans include:

1. They’re quick.
2. The loan review isn’t as arduous as with banks.
3. Borrowers who can’t get a conventional loan often qualify.
4. Properties that need too much work for a bank to be interested in often qualify.
5. They’re available if a traditional loan falls through while the property is under contract.

That’s not to say there aren’t downsides to using hard money loans. Some disadvantages include:

1. The cost of the loan can be expensive, with high interest rates and miscellaneous fees.
2. They’re risky to jump into since your property is collateral.
3. Repayment periods are shorter.
4. Some hard money lenders are after your money—and lots of it.

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How much do hard money lenders charge?

As noted above, the standard terms for hard money loans are expensive. But since these are short-term loans, they can still be absorbed with room for a healthy profit. While each hard money lender is different, normal loan terms look something like this.

• Loan to value/loan to cost: 65%–85%
• Lend on rehab costs: Yes
• Interest rate: 12%–16%
• Points: 2-6
• Other fees (will vary by lender):
  • Appraisal/broker’s price opinion
  • Title fees
  • Application fee
  • Inspection fee
  • Document processing fees
• Term: 6 months to 1 year
• Prepayment penalty: Usually none

Still, the loan amount ranges widely from lender to lender. For example, Taryn Kendrick, president and co-owner of Kansas City-based Worcester Financial, notes that while they do not charge an application fee or document processing fees, many lenders do. A broker’s price opinion (BPO) usually ranges from $150 to $250, and an appraisal can range from $400 to $650 (or substantially more if it’s a multifamily or commercial property).

The loan amount ranges widely from lender to lender and depends on the value of the property. Indeed, while Worcester Financial goes up to 75% of the loan to value (LTV) or loan to cost (LTC), they are willing to loan up to 65% of the after repair value (ARV) if that value is higher.

This means that on rare occasions, they have financed 100% of the cost of the property. This only happens for particularly good deals, however. Don’t go into a deal expecting this.

And to reiterate, what each hard money lender is willing to do is different. Some, for instance, may be willing to use other assets (say, another property) to “cross-collateralize” a loan. This type of flexibility is another advantage of hard money lenders.

Other hard money lenders may max out at 65% LTV, while some may increase to 85%. Remember to clarify whether a lender is referring to the LTV (what the property is worth) or the LTC (how much money you will be putting into the property).

Regardless, you will almost always need to find a way to raise the down payment. Potential sources include savings, a partnership, or a personal loan from friends or family. In certain cases with some lenders, as mentioned, another free and clear property can be cross-collateralized.

The bottom line is hard money lenders are generally more flexible than banks, and applicants have a better chance of negotiating adjustments to the terms or repayment schedule with a hard money lender than they would with a bank.

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How to get approved for a hard money loan

For private investors, he best part of getting a hard money loan is that it is simpler than getting a traditional mortgage from a bank. The approval process is generally much simpler. Banks can ask for an almost endless series of documents and can take several weeks to months to actually get a loan to committee. Most hard money lenders can close a loan in only five to 10 business days.

It is generally best to start building relationships with hard money lenders before you start making offers. This increases the likelihood of getting a deal done, as much of the groundwork has been laid before you need the money (ASAP!).

Many hard money lenders will also provide a conditional approval letter, which acts similarly to a bank’s pre-approval letter and which many sellers require to sign on the dotted line.

Hard money lenders still have a loan application form to fill out. They also generally still request two years of tax returns and two months’ worth of bank statements, as well as a schedule of the real estate you own, a copy of your driver’s license, and other such things. They look at your credit score too.

That said, there isn’t nearly as much paperwork or detail as with a traditional loan. The main purpose of these things is to make sure the borrower has an exit strategy and isn’t in financial ruin. But many hard money lenders will work with people who don’t have great credit.

The most important thing hard money lenders will look at is the property itself. Hard money lenders will request a BPO or an appraisal to assess the property’s current as-is value or determine the ARV.

They will also evaluate the borrower’s scope of work and budget to make sure it’s realistic. Sometimes, they will stop the process because they either believe the property is too far gone or the rehab budget is unrealistic.

Finally, they will evaluate the BPO or appraisal and evaluate the sales comps and/or rental comps to make sure they agree with the evaluation.

So, it’s not as simple as filling out a form and pulling out money. But still, there is another advantage built into this process: You get a second set of eyes on your deal, and one that is materially invested in the project’s outcome at that!

If a deal is bad, you can be fairly confident that a hard money lender won’t touch it. However, you should never use that as an excuse to forgo your own due diligence.

It’s also important to note the occasional bad apple among the hard money lenders out there (just like every other industry), which we will discuss how to avoid below.

Who is the best hard money lender?

As with any business, you have to be careful regarding hard money lenders. The key thing is to vet them in the same way you would any other key team member. (They will certainly be vetting you.)

You will also need to consider your situation to find the best hard money lender for you. Is this your first property, or are you an experienced flipper? Are you looking for someone focused on your needs? Someone fast? Which money lenders can you afford? Which hard money lender has the best reputation in your area?

These are some of the questions you should ask yourself when looking for a lender.

Don’t be afraid to ask for referrals, either. Good lenders won’t have a problem providing them.

The best place to look for hard money lenders is in the BiggerPockets Hard Money Lender Directory or your local Real Estate Investors Association. Remember, if they’ve done right by another investor, they are likely to do right by you.