The Common Types of Hard Money Loans
Hard money loans allow you to forgo traditional lenders and borrow money using only physical property as collateral. For those with bad credit and considered high-risk borrowers, hard money loans may be the only option. Although they're more expensive than traditional loans, they provide more flexible terms, faster delivery of funds, and much higher approval chances.
Most hard money lenders prefer collateral with securitization to make a loan. Real estate is an excellent vehicle to secure a hard money loan, providing the property in question has equity. That collateral reverts to the hard money lender if the borrower defaults and the home eventually go to foreclosure. After the Dodd–Frank Wall Street Reform and Consumer Protection Act was put into place, hard money lending was put under a microscope as Congress sought to protect consumers from predatory lending practices.
Common Types of Hard Money Loans
Mortgage refinancing is an example of a hard money loan. A refinance pays off one or more loans secured to the property, which results in a new loan, generally with a bigger principal balance and better interest rate. Homeowners can refinance without receiving any of the proceeds by either rolling the costs of the new loan into the principal balance or paying the costs of the loan out of the borrower's pocket.
Cash-out refinances, where a buyer takes out a new loan that is larger than the amount of the old loans and the costs to obtain the money, is a type of hard money loan. The remaining money is referred to as "cash to the borrower," and it is the net proceeds of the refinance. While homeowners will often use this money for large home improvement projects, it's not uncommon for someone to use it to pay off debts with high interest rates or tend to other financial needs. Many cash-out refinances are subject to deficiency judgments.
Equity loans are hard money loans that fund fairly quickly and are subordinate to an existing first mortgage. Bridge loans are hard money loans that are used by sellers who want to buy a new home before selling an existing home but need the cash from the existing home. You will see bridge loans used more often in seller's markets than in buyer's markets.
Equity loans aren't available in all 50 states.
People who borrow money from loan sharks typically can't get a loan from any other source because of bad credit, no assets, or questionable occupations. If you have an asset that can be used as security for the loan, you might go to a pawn shop, but if you have no item of value to trade for the money, a hard money lender, such as a loan shark, is the lender of choice.
Loan sharks make their money by charging very high interest rates that are often against usury laws, so it is not advisable to borrow money from them. The Loan Shark Prevention Act was introduced in 2019 to begin putting legislation in place to end these lending practices.
Hard Money Loans vs. Purchase Money Loans
A purchase money loan is money someone borrows to buy a home. The home can be almost any type of structure—single-family, multiple units, condominium, townhome, stock cooperative, or manufactured. Purchase money makes up part of the purchase price, and the loan is secured by the property, so if the buyer stops making the payments, the lender may have the right to seize the home and sell it to get their money back.
A hard money loan secured to real estate is not purchase money. It is money loaned to a borrower, but it is not always used to buy a home. You can get a hard money loan without owning a home at all, providing the lender feels you are a good credit risk. Some buyers use hard-money loans as a routine to buy investment properties that need fixing up. They will save their cash and pay high points to take out a hard money loan with a short repayment period. The problem with this approach is that some buyers write their purchase offers as all cash and show cash accounts as proof of funds. If they obtain a loan, however, the transaction is not all cash.
Congress. "H.R.4173 - Dodd-Frank Wall Street Reform and Consumer Protection Act." Accessed March 20, 2020.
Consumer Financial Protection Bureau. "Mortgages Key Terms." Accessed March 20, 2020.
Wells Fargo. "Cash-Out Refinance." Accessed March 20, 2020.
Federal Trade Commission. "Home Equity Loans and Credit Lines." Accessed March 20, 2020.
Congress. "S.1389 - Loan Shark Prevention Act." Accessed March 20, 2020.