The 2009 financial crisis greatly changed the way that banks do business both domestically and worldwide. Gone are the days when nearly any borrower can receive a loan for practically any amount they wish. Instead, banks are taking steps to reduce their risk profile and to ensure that borrowers do not leave the bank on the hook for large losses in the same manner that they did during the Great Recession.
One form of loans that has become more widespread in its usage since 2009 is the hard money loan. This type of loan requires a borrower to pledge real property as collateral to secure a loan. If the borrower defaults on the loan, the bank takes possession of the property. It does not matter to the bank whether a borrower defaults because they are able to take possession of real property in the event that the borrower does.
These loans are different than the typical loan in several other respects. First, these loans are for a shorter duration than the typical residential loan, usually one to five years. Second, hard money loans are interest-only loans, with only interest payable, until a large balloon payment is due to the bank at the end of the loan. Third, interest on these types of loans is usually higher than that charged for a standard residential loan. Sometimes, the interest rate exceeds 10%, with higher origination fees. Points on this loan start at two percent and can reach all the way up to four percent.
There are several advantages to obtaining this type of loan. While these loans are clearly more expensive than standard loans, they are also quicker and easier to secure than the standard loan. That is because banks have less risk than the standard loan because, if the borrower defaults, the bank receives the property securing the loan.
These loans are fast, flexible and not difficult to obtain and may be well-suited for those who need a short-term cash infusion. For example, home flippers, who purchase a home with the intention of making improvements and selling it for a profit, do not intend to own these properties for the long term. Therefore, it is less onerous for them to pay a high interest rate because they will not be paying it for long. Similarly, real estate developers who purchase properties in need of improvement are ideal users of these loans because they also do not anticipate owning these properties for a long duration.
These loans are a suitable means when a buyer needs to quickly obtain financing because some of the checks and processes that a bank imposes with a traditional loan are not necessary when the loan is secured with real property. This financing can often be given in less than seven days, as opposed to the traditional loan that can require up to two months for closing. They are also a fitting instrument when a borrower has bad credit, or no credit, and cannot otherwise obtain a loan.