What Are New Construction Loans?
A construction loan is used to finance the building of commercial or residential real estate. The loan applicant may be a real estate developer or an individual building a custom house. The loan is often short-term and is then replaced by longer-term mortgage financing.
Construction loans are considered relatively risky and usually have higher interest rates than traditional mortgage loans.
A construction loan may be sought by a builder or an individual to cover the costs of building or extensively remodeling a house.
Construction loans are usually short-term, about a year, and are then folded into a mortgage loan. A strong credit history is required as the loan is not collateralize.
Construction Loans are typically made under hard money lending guidelines such as
Hard Money Loans
A hard money loan is a type of loan that is secured by real property. Hard money loans are considered loans of “last resort” or short-term bridge loans. These loans are primarily used in real estate transactions, with the lenders generally being individuals or companies and not banks.
Hard money lenders do not operate the same as traditional money lenders. There are a few important areas to be mindful of:
Interest Rates: The interest rate that you’ll receive from a hard money lender will generally be higher than a traditional lender. This is so because the loan approval process does away with the traditional checks, increasing the risk for the lender. The higher the risk the higher the interest rate.
Loan Term: Hard money loans come with shorter terms. The shorter term benefits both the hard money lender and the borrower. The hard money lender has a shorter period they are lending money, which reduces their risk period, and borrowers don’t have to pay a high interest rate for a long period of time.
Approval Metrics: Most traditional lenders approve a loan or the amount of a loan on standard industry metrics, such as accepted debt-to-income ratios. Hard money lenders set their own standards on what is acceptable.
Oversight and Regulation: Hard money lenders are similar to payday lenders in that they don’t have much oversight or regulation to abide by.
Advantages and Disadvantages of a Hard Money Loan
As with any financial product, there are advantages and disadvantages to hard money loans. These loans are quick and easy to arrange and have high loan-to-value (LTV) ratios, but also high interest rates.
Advantages
One advantage to a hard money loan is the approval process, which tends to be much quicker than applying for a mortgage or other traditional loan through a bank. The private investors who back the hard money loan can make decisions faster because the lender is focused on collateral rather than an applicant’s financial position.
Lenders spend less time combing through a loan application verifying income and reviewing financial documents, for example. If the borrower has an existing relationship with the lender, the process will be even smoother.
Hard loan investors aren’t as concerned with receiving repayment because there may be an even greater value and opportunity for them to resell the property themselves if the borrower defaults.
Disadvantages
Since the property itself is used as the only protection against default, hard money loans usually have lower LTV ratios than traditional loans: around 50% to 75%, vs. 80% for regular mortgages (though it can go higher if the borrower is an experienced flipper).
Also, the interest rates tend to be high. For hard money loans, the rates can be even higher than those of subprime loans.
Another disadvantage is that hard loan lenders might elect not to provide financing for an owner-occupied residence because of regulatory oversight and compliance rules.
What Are the Typical Terms of a Hard Money Loan?
Hard money loans are a form of short-term financing, with the loan term lasting between three and 36 months. Most hard money lenders can lend up to 65% to 75% of the property’s current value at an interest rate of 10% to 18%.
Is a Hard Money Loan a Good Investment?
It depends on what you use the money for. Hard money loans are a good fit for wealthy investors who need to get funding for an investment property quickly, without any of the red tape that goes along with bank financing. They can be useful to pay for a one-time expense or project, but only if you are reasonably sure you’ll have the money to pay back the loan.
What Are The Risks of a Hard Money Loan?
Hard money lenders typically charge a higher interest rate because they’re assuming more risk than a traditional lender would. They may require a higher down payment than a traditional loan would, and you’ll have a shorter period to pay back the loan.
The Bottom Line
Hard money loans are typically used by real estate investors, developers, and flippers. They can be arranged much more quickly than a loan through a traditional bank, and loan terms are generally short: six to 18 months.
Hard money loans may be sought by investors who plan to renovate and resell the real estate that is used as collateral for the financing. The higher cost of a hard money loan is offset by the fact that the borrower intends to pay off the loan relatively quickly.
