People often ask about “hard money loans” and the truth is they should be called hard money loans because it would be hard to imagine paying the rates and fees associated with them.
A hard money loan is a loan made by a non bank institution (often wealthy individuals or investor groups) to someone who has demonstrated a failure to manage their finances correctly resulting in an ultra low credit score (a middle credit score (a.k.a. FICO) of less than 500). Some lenders now even consider borrowers with credit scores less than 400!
Here are the pros and cons:
PROS:
1. A borrower with ultra low credit scores can purchase a home. This can be a good thing or a bad thing. If they are ready to make a change and pay the mortgage on time, this COULD help reestablish the credit (more in cons). If they do not make timely payments, they will lose the house AND the LARGE down payment required.
2. Tax savings for home ownership. Your interest should be tax deductible, even from a hard money lender, provided it meets all other IRS criteria. For more info read IRS Publication 936 (Home Mortgage Interest Deduction.)
3. Can be used to pay off a Chapter 13 bankruptcy or other major debt if you are a home owner. This should be a last resort and analyzed carefully as it may make things worse. Always discuss mortgage and finance matters with a qualified professional.
4. Can be obtained to avoid foreclosure. As with #3, this needs to be analyzed with the help of an expert.
CONS:
1. LARGE Down payment. Hard Money lenders normally do not lend more than 70% of THEIR assessed value of a property. This means you will need to have a down payment (or equity) of at least 30% (some will go up to 80%).
2. HIGH RATES & LOTS OF FEES. Hard Money Lenders are not your local neighborhood bank. They really aren’t looking to help you get into a home; rather they are looking for a strong return on their investment. Currently, you will pay somewhere in the 12% range for an interest rate and at least 4 points in additional closing cost. (A point is 1% of the loan amount paid up front to ensure the investors minimum return on their money).
3. MAY NOT BE REPORTED TO CREDIT BUREAUS. Your loan will most likely not be reported to the credit bureaus which means paying it will not help restore your credit in a traditional sense. If you end up with a hard money loan for a mortgage, I recommend keeping copies of your cancelled checks (not money orders) for your records. Some subprime lenders may accept this as evidence of timely payment and may refinance you after 6 to 12 months of on time payments.
4. POTENTIAL FOR FORECLOSURE OR REPOSSESSION. Unlike banks, who don’t like to foreclose on properties, a hard money lender makes money by foreclosing on properties with delinquent payments. Their large down payments ensure that they will not lose money, so do not use a hard money lender if you are not 100% sure you can make your payments on time. Of course, life changes happen – people get sick, lose jobs, and get divorced – all I am saying is do not go into a situation when you already know you cannot make the payments to a hard money lender.
For clarification. A hard money loan is NOT the same a a sub prime loan. A sub prime loan is a loan made to someone with low credit scores, but usually above 500 and usually require less money down. Sub prime loans are made by institutions and can help borrowers restore their credit with on time payments and can often help a borrower that has had a bankruptcy, foreclosure, or other financial crisis.