Hard money lenders provide borrowers with loans that are backed by some form of real estate. The borrower may use their property interest in a residential or commercial property as collateral for the loan. These loans are often called “bridge loans.” Private Individuals or private companies usually offer hard money loans as opposed to the type of lending institutions that make traditional mortgage loans for home purchases.
Hard money loans are usually short-term, non-conforming loans made for commercial or investment properties, although they can be used by people who want to buy a single-family residence for their own use. The fact that they are non-conforming means that they do not meet the federal Fannie Mae and Freddie Mac’s standards for purchase.
Fannie Mae and Freddie Mac are government-sponsored entities that invest in mortgage loans. The rules regarding the type of mortgage loans that Fannie Mae and Freddie Mac can buy come from the Federal Housing Finance Agency (FHFA). Borrowers who do not qualify for Fannie Mae and Freddie Mac loans might use a hard money loan for a home purchase.
A hard money loan contract is secured by the property that the loan proceeds are used to purchase. In this regard, it is just like a traditional mortgage loan. The real property asset that secures the loan is the “hard” part of a “hard money” loan. As with a traditional mortgage loan, if the borrower defaults on a “hard money” loan, the lender can foreclose on the property that secures the loan in order to cure any non-payment.
What Are Some Characteristics of Hard Money Lender Transactions?
Hard money loans often have some of the following characteristics:
- They may be easier to obtain in terms of qualifying on the basis of a person’s credit score, as the hard money lender often does not perform the standard credit checks, including getting credit reports from the three major credit reporting agencies. They may also not follow loan approval guidelines that are standard in the industry.
- The borrower may not qualify for conforming loans because of a poor credit history or other financial handicap;
- The lender may charge higher interest rates on a hard money loan than they would charge on other types of loans because the approval of the borrower and the loan does not meet standard requirements. As a result, these loans often present the risk that the borrower will default on repaying the loan.
- To counteract this risk of default, hard money lenders often lend at higher interest rates;
- The loan term is typically shorter than a traditional loan, especially one that is secured by real estate. The loan term may be less than 10 years. Most residential mortgages have terms of 15 or 30 years. This shorter life of the loan can mean that monthly payments are going to be higher in some cases.
While hard money lenders may not always require an extensive check of the borrower’s credit for approval, they are required by law to verify a borrower’s “ability to repay.” This means that they are usually required to verify documentation of the borrower’s income.
What Are Some Risks of a Hard Money Loan?
There are risks to hard money loans. Some of them are as follows:
- The lender charges higher interest rates than are charged for other types of loans. So they are more expensive to the borrower;
- The lender often requires large down payments;
- The shorter loan terms mean there is less time to repay the loan;
- The loans are allegedly riskier than traditional financing;
- The borrower may have to have a track record of successful house flips if the borrower is taking out the loan to finance a house “flipping” project in which they buy a property, renovate it, and then resell, hopefully at a profit.
If a person is not interested in a hard money loan, there are alternatives as follows:
- Private Money Loan: A person can ask family members, friends, or others for a private loan. Of course, there could be risks in this approach as well because failure to repay may sour family relationships or friendships. Although it may have its own special kinds of risk, it could be an option;
- Home Equity Line of Credit (HELOC): A HELOC is useful when a person wants to undertake a home improvement project to increase the value of their home;
- Homestyle® Loan: Another option is a Homestyle® loan from Fannie Mae. It’s a government-backed mortgage that allows a person to renovate their own family residence and not for “flipping” purposes.
Hard money loans can be a useful tool if a person needs financing through a less traditional route. However, these loans come with higher interest rates and a significant amount of risk if a person uses them for an investment that is not as profitable as they hope. In general, some experts caution that they are best for professional investors and not the average homeowner.
Experts advise that if a person’s application for a traditional mortgage from a financial institution has been denied, it is better for the person to explore other options. These options include working to improve their credit rating or applying for a mortgage program such as the FHA loan program that accepts people who have a poor credit history.
What Are Some Legal Issues Associated With Hard Money Lenders?
Hard money lending can often be associated with specific legal issues. These include:
- Licensing: Hard money lenders need to obtain the proper licenses and certifications in order to make hard money loans. For instance, they need special licensing if the property to be used as collateral is residential property. Without proper licensing, any loan would not be considered valid;
- Fraud: Some hard money loans may be subject to various loan fraud and misrepresentation issues on both the lender’s and the borrower’s side;
- Prepaid Interest: Lenders generally cannot require more than two months of prepaid interest for loans backed by residential property. This may be different for loans backed by commercial property.
Legal disputes over a hard money lending contract can often lead to a lawsuit. These may be remedied through a damages award that helps to reimburse the non-breaching party to the contract for their losses. In some serious cases, a case might involve criminal charges in the event that the fraud, the deception of a government official, or other potentially criminal conduct.
Should I Hire a Lawyer for Help With Hard Money Lender Issues?
A hard money loan may be an appropriate choice for you, depending on the circumstances of your situation. Hard money loans can often help a person obtain funds in a short amount of time, with fewer creditworthiness requirements. However, they are also associated with certain risks and possible penalties.
LegalMatch.com can connect you with a qualified credit attorney if you need help with a hard money loan. Your lawyer can help you research your financing options and advise you as to which options best serve your financial interests. Of course, your lawyer can negotiate on your behalf if disputes arise and can also represent you if you need to file a lawsuit with the court.