Besides conventional loans, investors can finance a property purchase in many ways. However, that doesn’t necessarily mean that other solutions are better. For example, hard money loans are more suited for property owners that want to fast-track a buy, have a low credit score, or want more negotiation power. While those perks sound great, like everything else in life, they have their drawbacks, some of which we’ll discuss today.
Stay tuned as we reveal the top 3 risks of hard loans. If you’re an experienced landlord, you might pick up a few tricks, but this article is mainly a tailored guide for new investors in 2023. Thus, if you want to get your real estate business off the ground, or are experiencing difficulty with the recent chill in the market, stick around till the end.
Top 3 Risks of Hard Money Loans
1. Interest Rates
One of the most significant risks of taking out a hard money loan is that their interest rates are typically higher. As we highlighted in the introduction, they come with a fast approval rate than traditional bank loans. However, their speed is because they consider credit scores and income histories less critical. Thus, that often means they have to assume a lot more risk. Consequently, it makes sense for such lenders to hike their interest rates if borrowers fall short of their promises. Thus, it can mean paying more for your property in the long run than going for the standard bank loan. However, you can find a reputable lender to help minimize the risks of your loan.
2. Short Period of Time
Another drawback of taking out a hard money loan is that they’re often short-term loans. You can usually split your payments across 10 – 20 years with conventional financing. Some banks can even extend your credit for up to 30 years. However, private lenders work with shorter terms of 1 to 5 years, with some exceptions. Hence, any money you intend to borrow should be something you can return within a short period.
3. Large Down Payment
Most traditional loans require around a 20% down payment or less to qualify. On the other hand, hard money loans typically require borrowers to put down more money upfront, with averages around 25 -30%. Thus, this mode of financing could be unrealistic for some investors, especially if you’re strapped for cash.
How to Reduce Risks of Using Hard Money Loan
One of the hard money frequently asked questions investors often have is how to reduce the risk of such a financing strategy. Well, here are a few tips to guide you if you’re thinking of getting such a loan:
1. Read the Terms Carefully
This tip might seem obvious, but you’ll be surprised how many borrowers skip this step. Often investors will skim through a contract and hastily sign on the dotted lines to get the capital they need. Unfortunately, such behavior could leave you saddled with unfavorable terms. A tell-tale sign is also when the lender offers terms that are “too good to be true.” No one will dash you money, so if an offer seems too perfect, you should do some more digging.
2. Beware of Social Media Lenders
While you can use social media to your advantage to find reviews and stories about specific organizations, reliable lenders rarely reach out to people online. They might run ads on their official page, but they usually refrain from sending you spam emails or direct messages. Any lender desperate enough to reach out to strangers on the internet might be up to some shady practices. Thus, it would be best to stick with genuine and well-known brands.
3. Check the Lender’s Registration
If you’ve done your research and are unsatisfied with the lender’s authenticity, you can check them on NMLS’ website. Short for The Nationwide Multistate Licensing System, this body is responsible for licensing and keeping a record of all approved lenders in the country. Thus, if your lender doesn’t have any data with them, you risk falling for a scam.
4. Ask for Referrals
For the best results, you should go out of your way to ask for referrals, especially from people within the industry. For example, real estate agents, property managers, and other investors would likely have good recommendations for hard money lenders. Also, they might be able to shed some light on whom to avoid.
Conclusion
Hard money loans are a popular financing solution for investors with low credit scores or who need swift approval. However, as a new investor, you should note that this type of financing comes with its burdens. The top 3 risks of hard money loans are higher interest rates, shorter borrowing time, and larger down payments. These drawbacks can make it more difficult for borrowers to purchase property under reasonable terms at a good rate. But there are ways to mitigate these risks, and you should adopt such strategies to protect your investments.
