Hard money loans represent an alternative form of financing. Also known as bridge loans in some circles, these are short-term loans designed to meet immediate, but temporary, financing needs. They can be a very good financial tool under some circumstances. But as with all things in the financial sector, the devil is in the details.
It is important to know the details of any loan product before you sign a contract. Yet knowing the details is so much more important when you are dealing with hard money loans. Why? Because, by their nature, they are distinctly different from traditional loans. Not knowing the details could mean getting yourself into something you’re not prepared to deal with.
How Hard Money Loans Are Structured
Nearly all loans made at the retail level are structured in one of two ways: as installment loans or interest-only loans. Do you know the difference? If not, it would behoove you to learn before you agree to take on a hard money loan.
Installment Loans
An installment loan is a loan you pay over time by way of monthly payments. Each payment is known as an installment. Mortgages and car loans are good examples. There is a fixed amount you will pay over the term of the loan. Interest and fees are calculated and added to your monthly payments.
Interest-Only Loans
Interest-only loans are structured in such a way as to minimize monthly payments. You are still paying monthly but are only making the interest payments. You make a single balloon payment on the loan’s maturity date to pay off the principal amount.
According to Salt Lake City’s Actium Partners, lenders routinely structure hard money for real estate as interest-only loans. In some cases, borrowers do not have to pay anything until the actual maturity date. But such loans are a rare exception to the rule.
Hard Money Rates and Terms
Next, do you understand how rates and terms affect the total cost of borrowing? As far as rates go, you are looking at both standard interest rates and annual percentage rates (APRs). The standard interest rate is the rate at which the lender charges you interest. A loan’s APR combines the standard interest rate with all the other fees and charges you pay.
Meanwhile, a loan’s terms stipulate how and when payments are made. An installment loan with a 30-year term would have you making 360 monthly payments. A two-year interest-only hard money loan would have you making 24 monthly interest payments and one principal payment at the end.
As a general rule, longer terms mean more interest paid. A 5% interest rate would cost you less on a loan with a 7-year term compared to a similar loan with a 10-year term. That’s because interest is charged annually on the outstanding principal. You are better off pushing for shorter terms even if that means a slightly higher interest rate.
Additional Fees and Charges
Hard money lenders are similar to traditional lenders and they make additional money from fees and charges. There are origination charges, title transfer charges, inspection fees, and so on. All those extra fees and charges add up over time. Make sure you know what they are before you sign on the dotted line.
Hard money loans can be a better option than traditional funding for certain needs. Anyone hoping to obtain a hard money loan would be wise to do their homework first. It is especially important to know the details before signing the loan contract. You can take that to the bank.
