Traditional mortgages are stressful. The whole process of applying, collecting the paperwork, negotiating back and forth, feeling like you have to do penance for your past credit mistakes…the whole thing is just not fun. Some potential homeowners may want to circumvent the process altogether by looking for a different source of funding. One of those sources you may have heard about (since you’re here on dohardmoney.com) is a hard money loan. But what is a hard money loan, and can you use hard money to buy a personal residence?
Technically yes, hard money can be used to finance an owner-occupied home. These loans are especially appealing to those who have bad credit reports or dodgy employment histories. Hard money loans are vastly different from mortgages in many important factors including amount of funding, duration, and interest rates. While lenders may be willing to give hard money loans, it might be too big of a gamble for the homeowner to take.
But I’ll cover that all in a minute. First, let’s talk about what exactly a hard money loan is and how it’s different from a traditional mortgage. Plus, I’ll give you some insight into what you’ll need to consider before going this route and the consequences if your hard money loan goes into default, because it gets ugly. Let’s get to it.
What is a Hard Money Loan?
Hard money loans are financing typically used by fix & flippers because they can lend on properties that a traditional bank won’t touch. They’ll also get you the money fast enough to take advantage of a deal you’re looking at. And, they can be used for your primary residence, but that’s much rarer. The company lending the cash out is rarely a bank; more often, they’re a company that specializes in financial help for real estate investors.
Hard money loans can also be borrowed from private persons who aren’t tied to any company (usually called “private money”), but this can get complicated. Terms will need to be established and both parties should have a good understanding of what a hard money loan is and, more importantly, is not.
How are Hard Money Loans Different than Traditional Mortgages?
While mortgages and hard money loans both go towards purchasing a property, the similarities stop there.
For one thing, hard money loans are much more lax when it comes to background checks, employment history, and credit reports. A traditional lender will put a lot of stock into these, and any stains on these records can cause your mortgage application to be denied. Hard money lenders, however, are more lenient.
Another appeal of hard money loans is the speed. Typically hard money loans can be financed within a matter of weeks, possibly even days. However, a traditional mortgage will take much longer due to the amount of research into your creditworthiness and history.
That’s the good news when it comes to hard money loans. Here’s the bad. And when I mean “bad,” I just mean “different” because these loans absolutely have their benefits for those who know how to use the loan as leverage. It’s just a matter of understanding that in owned-occupied situations, the drawbacks can be significant. Hard money loans:
- Will have a much shorter duration, usually anywhere from 1-3 years. You may find a lender willing to go a little longer, but rarely will you get any higher than a five-year cap.
- Will have a higher interest rate. (see the table below for an idea of how much higher.)
- Will never be for the total purchase price of a home when used in lieu of a conventional mortgage. These loans are usually anywhere from 60 – 75% of the current property value. There are lenders who will finance based on the After Repair Value (ARV), but since you’re not looking to fix & flip the property, this wouldn’t be a consideration.
You need to think about hard money loans in the scope of what they are, not what someone wants them to be. This type of funding was created to help real estate investors bridge the gap between what they have and what they need to flip a property for a profit.
Unfortunately, most banks won’t give much extra over the home appraisal, so homeowners may find themselves underwater quickly. Hard money lenders expect to be paid back quickly, typically with funds paid from the mortgage. This makes it difficult for “retail” buyers to utilize funds like this unless they can recoup the loan from the mortgage. You may be able to leverage a HELOC once you build some equity, but that can be difficult to do when you’re making multiple monthly payments and have two new significant loans on your credit report.
Can I Use a Hard Money Loan for My Own Home?
So, knowing all of these things, can you still get a hard money loan for a personal home? In theory, sure. There’s nothing legally stopping you from financing your home through a hard money loan.
That said, you may find it difficult to find a hard money lender who wants to work with you. Lenders in this industry focus mainly on real estate investors as they know the loan will be paid back from either the profits of a sale or the mortgage. Whatever is taken out of the mortgage presumably is covered by the profits from selling the home. Since there aren’t any short-term profits to be had with your own home, the lender would be taking on much more risk. Long story short, it’s going to be a tough sell to get a hard money lender on board.
But another point to consider: Do you really want a hard money loan? As I mentioned above, hard money loans have a significantly higher interest rate than traditional mortgages. Check out the current average rates for these three sets of loans used for homes:
|Type of Loan||Duration||Average Rate (2021)|
|Hard Money Loan||1-3 Years||11.25%|
That is a huge difference! Are you willing to bet you can pay off the principal and interest within three years in addition to making payments on your mortgage at the same time?
What Would Happen if I Couldn’t Pay Back My Hard Money Loan?
On the off chance that a hard money lender was willing to lend you for your primary residence, you need to understand what your obligation is to them.
Hard money lenders work on collateral, with the collateral being your property. If you default on your loan to them, the lender can take the home from you and sell it to recoup their losses. Keep in mind that, in addition to your hard money lender, you’d also be on the hook to your bank for the mortgage (if you got a conventional mortgage and a hard money loan as gap financing). Just because the hard money financier took ownership of the home doesn’t mean your mortgage obligations will disappear. It’s just now you’re in the hole for the mortgage and don’t have the house to show for it.
Hard money loans are an excellent resource for real estate investors who need a quick cash infusion to flip a property for profit. And while they technically can be utilized by homeowners, it’s critical that you, as the homeowner go into this with your eyes wide open. Understand the significant differences between this type of loan and a mortgage before applying for either. If you’re unable to get traditional financing, a hard money loan may be an option. But, in the end, it may be better to fix your credit issues and go with a traditional mortgage instead.