What Is A Hard Money Construction Loan
A hard money construction loan is used to fund real estate projects such as building, renovating and upgrading. What makes a hard money construction loan different from ordinary loans is that it uses the property’s equity as collateral, thus the term “hard money.”
Lenders only consider potential profits from the hard money construction loan, based on the property value, volatility, and current market conditions, rather than credit history and financial status when evaluating borrowers. This makes it a popular choice for borrowers who do not qualify for conventional financing either because they have poor or nonexistent credit or are in current financial distress (such as imminent foreclosure or bankruptcy).
Real estate investors can also use a hard money construction loan to fix up investment homes for a quick profit, which usually requires short-term financing. Banks do not usually offer a hard money construction loan; they are more often provided by small specialized companies or individuals, and sometimes may have to be obtained through brokers to get the best rates.
How Does A Hard Money Construction Loan Work
The nature of a hard money construction loan makes it particularly attractive to borrowers with high risk profiles. Because they are taking on more risk—that is, the borrower is more likely to default on the loan—lenders charge much higher interest rates and impose much stricter terms than conventional loans. It’s not uncommon for a hard money construction loan to carry an interest rate over 15%, and to charge sizable fees for late payments.
There may also be origination fees as large as 10% of the amount being borrowed, and loan-to-value ratios as low as 65% to further cushion lenders against the risk. Also, a hard money construction loan is usually short-term, lasting a year or so in most cases. This puts more pressure on borrowers to pay on time and avoid the penalties. Most people consider a hard money construction loan only as a last resort after being turned down for traditional financing, although some investors deliberately choose it to avoid the lengthy evaluation process in most commercial lenders.