Hard money lending is a form of asset-based lending popular with real estate investors, house flippers, developers, etc. Even small businesses turn to hard money when banks are unwilling to help them meet their financing needs. Suffice it to say that hard money has a lot to offer.

If you are new to the whole hard money thing, don’t just rush in and start looking for loans. Do some research first. Make sure you have at least a basic understanding of how it works so that you do not make a decision that could come back to bite you. With that in mind, here are three things that newbies should know about hard money lending before diving in:

1. Collateral Is King

Borrowers have an easier time obtaining hard money loans for risky ventures, like house flipping and real estate investing, because credit histories and income statements are not required. Instead, collateral is what lenders are after. You could say that collateral is king.

When hard money is used to fund a real estate transaction, the property being purchased acts as collateral on the loan. Title to the property is held by a third party until the loan is paid off. In the event of default, the lender takes possession of the property and that’s that.

As a side note, collateral on a hard money loan doesn’t have to be real property. There are cases when small businesses apply for hard money loans to fund expansion. Rather than offering real property as collateral, they might offer business equipment or other tangible assets.

Hard money lenders are free to accept any kind of collateral they like. Real property is the most common form of collateral only because most hard money loans go toward financing property acquisitions.

2. Substantial Down Payments Are Required

Hard money lenders require borrowers to put their own money down. How much depends on lender policies and the projects they consider financing. But according to Actium Partners in Salt Lake City, UT, down payments tend to be substantial. Hard money lender terms tend to change according to lenders.

It is rare to come across a hard money lender willing to offer an 80%-90% LTV. Even 75% isn’t the norm. Down payment requirements typically run anywhere from 30% to 50%.

The combination of downpayment and collateral value need to be more than enough to support the loan. Hard money lenders do not want to be landlords, so they take every precaution to minimize their risks. Substantial down payments are part of that.

3. Hard Money Loans Are Interest-Only

Hard money lenders tend to structure their loans as interest-only loans. What does that mean? It means monthly payments cover only interest. A typical scenario involves calculating monthly payments by taking the amount borrowed, multiplying it by the annual interest rate, and then dividing it by 12.

Also note that interest payments are amortized according to a loan’s payment schedule. If a loan term is 18 months, interest payments are calculated the same way every month until loan maturation.

When the maturation date is reached, the borrower is expected to pay the entire principal. In essence, it is a balloon payment. Failing to make that payment amounts to default.

Hard money is a fantastic financing tool for certain types of commercial needs otherwise not well met by banks. As private lenders, hard money lenders have more flexibility to address projects that banks will not touch. That said, hard money isn’t a free-for-all. Lenders are very particular about who they lend to and the amount they will offer. If this is all new to you, do your homework before you start looking for loans.

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