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Few people looking to buy a home have the cash on hand to make the entire purchase without resorting to some form of loan. For those who do need to take out financing, there are a number of options available. The most common of these is a traditional mortgage. But traditional mortgages come with a number of serious drawbacks. The approval process may take up to three months to complete, leaving buyers in competitive markets seriously vulnerable to those who can raise capital faster. Mortgages may also have strict and even onerous approval requirements, making it difficult for people with poor credit to have any chance at being approved.

Mortgages also frequently require huge up-front costs. These come in the form of closing costs, origination fees and down payments. A typical $100,000 home purchase may involve use of a mortgage that requires up to $25,000 down. An additional $5,000 may be charged in fees and origination costs. For many buyers, assuming all of these costs, delays and risks may make sense. But for some, alternative forms of financing may be preferable.

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What is a hard money loan?

A hard money loan is a non-traditional form of financing that is used by some real estate purchasers to push through deals that would be difficult or impossible using traditional mortgages. Hard money lenders are typically not banks. They are individual investors or groups of investors who look for opportunities to profit from short-term loans to specific buyers. Because hard money lenders are not associated with large banks, they have much greater flexibility in the terms of the loans they set as well as the approval requirements.

Hard money loans are usually extended on much shorter terms than traditional financing. According to DelanceyStreet, absolute high end for hard money loan terms is around 18 months. Many hard money loans are made on terms as short as 30 days. While hard money loans typically charge far higher interest rates, the up-front costs are typically only a fraction of those of traditional mortgages.

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The low up-front costs are a result of hard money loans being fully secured by the underlying collateral. Different forms of collateral can be used, including the property being purchased or other real properties, such as the borrower’s own home or other commercial real estate that they may own. Because the loan is fully secured, hard money lenders are often far less concerned about the long-term ability of the borrower to repay the loan.

This means that hard money lenders can also get cash into the hands of borrowers on incredibly short time frames. While approval for a typical mortgage can easily take two months or longer, once a real estate investor has an established relationship with a hard money lender, they may be able to get cash in hand in as little as a couple of hours. Such rapid approvals and cash delivery can make a huge difference in competitive real estate markets, where hard money borrowers can enjoy many of the same advantages as cash buyers, being able to quickly nab homes that are priced to sell.

While hard money loans can be a great tool for savvy real estate investors, they can present risks to the less sophisticated. Hard money is generally not desirable for use in purchasing homes in which someone plans to live. This is because interest rates on hard money loans may run well into the double digits, requiring quick refinancing for anyone who plans on holding a property over the long term.

Hard money loans also require investors to have significant assets with which to secure the principal amount. Because many home buyers do not have assets that are valued far greater than the real estate they are looking to purchase, use of hard money loans may not be feasible for many home buyers.

Low loan to value ratios are also an issue with hard money loans. Typically these values may be as low as 50 percent.