Real estate investing can be a lucrative source of income, but as the saying goes, one must spend money to make money. Obtaining a loan through a bank has many advantages, but the process can be slow, and a bank’s conditions for approving a loan can be steep. Investors who need a loan in a shorter time frame, or who are not eligible for a bank loan, might consider hard money lending. Hard money loans come from private companies or investors rather than banks. These loans could be advantageous for some California real estate investors, but they also carry certain disadvantages and risks.
What Is Hard Money Lending?
Perhaps the three most important features distinguishing hard money loans from other types of financing are that (1) the lenders are private businesses or investors, rather than banks; (2) the repayment period is typically much shorter than that of a bank loan; and (3) interest rates, origination fees, and other expenses are usually higher. In short, hard money loans allow investors to skip many of the hurdles in a bank’s loan application process and obtain money much faster, but at a greater cost and with a shorter repayment period.
Hard money loans are secured, meaning that borrowers pledge something as collateral. This is usually the real property that is the subject of the loan, but unlike a bank, a hard money lender may not require this. The lender and the borrower may agree to use something else of value as collateral, like an investment or retirement account. This is just one example of the added flexibility that might be possible with a hard money loan.
When Might an Investor Need a Hard Money Loan?
As mentioned earlier, two of the biggest advantages of hard money lending over bank financing are speed and flexibility.
Speed might be important when an investor needs a quick infusion of cash in a project. Hard money loans are similar to bridge loans in this regard. The price of a hard money loan’s quick availability is a higher interest rate and a short repayment period, possibly measured in months rather than years. The lender is also an investor, and the higher interest is their compensation for moving quickly, and for added risk.
Flexibility might appeal to a borrower who cannot obtain financing from a bank for any number of reasons, such as a low credit score. Hard money lenders primarily look at the property when deciding whether to make a loan, rather than the borrower. The estimated value of the property once the borrower has applied the money from the loan is far more important to a hard money lender than the borrower’s creditworthiness.
Hard Money Lending and the Law
Few laws directly address hard money lending, although usury laws might prohibit lenders from charging excessive interest rates. In California, hard money lenders must obtain a license, through either the state or the National Mortgage Licensing System (NMLS).
The California Bureau of Real Estate issues licenses for real estate brokers. This license, along with the mortgage loan originator endorsement, is generally required by the NMLS/SAFE Act for hard money lenders involved in residential real estate. Lenders who work in commercial real estate may need to obtain a license from the California Department of Business Oversight, under the California Finance Lenders Law.
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