What is a Hard Money Rehab Loan?
A hard money rehab loan is a financing option short-term and long-term investors can use to fix up properties for eventual sale. Short-term investors use hard money rehab loans to buy properties, renovate them, and sell them at a profit. Long-term investors, on the other hand, use hard money rehab loans to rehab properties before refinancing them.
How does it work?
Great for fix-and-flip businesses, a hard money rehab loan is a short-term loan that is secured by real estate or property. There are a variety of lenders who offer hard money rehab loans, but typically your small, local hard money lenders will be able to provide a broader range of rates, fees, terms, and qualifications. Rehab lenders are fundamentally hard money lenders with a higher level of knowledge of rehab projects than a typical hard money lender. Rehab lenders tend to finance real estate investors who are looking to fund a fix-and-flip project or who want to rehab and refinance a property. On top of covering the cost of the property, rehab loans will also cover the cost of the repairs.
Hard money loans are also typically interest-only, meaning your first payments will be smaller, covering just the interest on your loan, with your later payments being much larger to chip away at the principal. Also, hard money loans usually require a down payment of around 25%, which might be difficult to meet for some individuals or companies.
Compared to a traditional mortgage or loan, your creditworthiness isn’t used to determine if you qualify for a hard money rehab loan. Hard money lenders can move forward without strict credit requirements since the loan is secured by the value of the property. If you are struggling getting approved for traditional financing as a result of your recent borrowing history, you may still qualify for a hard money rehab loan if you have sufficient equity in the real estate to put up as collateral (you may also want to check out our credit rebuilding guide).
Interest rates for hard money rehab loans tend to range between 7.5% and 12%, which is much higher than other conventional mortgages. The high interest rates are direct reflections of the riskiness of these projects and the shorter period during which interest will be charged. It’s essential to remember with a hard money rehab loan that you will be making interest-only payments and repay the full loan amount at the end of its term.
In addition to interest, there is a cost that comes with the loan referred to as “points.” Points are a percentage of the loan amount and are the cost of borrowing money; think of them as the transaction fees. This cost ranges from 1-10% of the total loan amount.
Credit requirements for hard money rehab loans tend to differ per lender, however, it’s common that you will qualify for a hard money rehab loan with a low credit score. Lenders typically require that your credit score is at least 550. In addition to this, most require that you have some past real estates experience, such as one or two completed projects, or a background in construction. If you don’t have that experience, it’s still possible to get approved if you’re working with a licensed contractor.
Advantages and Disadvantages
Hard money rehab loans are perfect for those looking to fix a house before selling it or to buy rental properties that are in need of renovation. With lower credit requirements compared to those of a traditional mortgage, they are easy to qualify for. In summary, the pros of a hard money rehab loan are quite simple: shorter-term loans with interest-only payments and fast approval times that cover the purchase of a property and the renovation financing all in one loan.
A major drawback of a hard money rehab loan is the cost of the loans. Characterized by high-interest rates and points up to 10% of the loan amount, they tend to be too expensive for some to consider worthwhile. In addition to this, with high costs come higher risks; it’s easy to default your transaction and lose your property to the lender if you are unable to make difficult payments. Another drawback is that you will need to put down 25% of the loan amount using cash. This is tough for some as it is a large chunk of money especially with higher loan amounts.
How to Get a Hard Money Rehab Loan
Most hard money lenders have a pre-qualification process to help investors project the costs, fees, and terms of a rehab loan which only takes a few minutes to complete. Once you provide your lender with your financial information and information about the property you want to finance, they will evaluate if they can pre-qualify you.
Once a lender prequalifies you, you can begin working toward the final approval for your loan. After finalizing the property you want to finance, you will need to provide the lender with the necessary documents, such as your purchase contract, a list of past projects, and a document summarizing the scope of the rehab work to be done. If the lender decides to move forward with your loan, and you accept all the terms, the loan will be funded. The funding process typically takes anywhere between 10 and 15 days for the purchase price.
It’s important to keep in mind that there is a large chunk of money that will be due upfront. Lenders require you put down 25% of the total loan amount in cash as an incentive for you to make your monthly payments.
If you are a less qualified borrower and are looking to get cash to rehab a property that won’t qualify for a traditional loan, a hard money rehab loan could be the right option for you. With high interest rates and a short repayment schedule, it’s important to know if you will be able to handle the risk a hard money rehab loan before signing on. Ideally, you would want to use a hard money loan if you couldn’t qualify or find traditional financing for your property; it should be considered a last resort for getting money for a real estate investment.