Businesses take on far more debt than most people think about. The world’s largest companies all take out countless millions and billions of dollars as a means of growth. However, businesses always have a plan for their debt. They don’t take out car notes on vehicles that look cool or get lots of compliments; rather, businesses take on oodles of debt to buy fully-functional fleets of vehicles, for example, to better keep up with their competition, satisfy customers’ demands, and otherwise substantially benefit their businesses’ welfare.
Individual real estate investors – not companies, businesses, or corporations – almost always take out loans to purchase homes, land, and other assets they’re looking to quickly flip or even tack on to their portfolios for the foreseeable future.
Banks typically don’t offer loans to individuals who ask for principal amounts in the capacity that most personal real estate investors do. It’s not like these investors can take out tens of credit cards, drain their collective stash of plastic with available cash advances, accumulate that money, and simply take out 50 more credit cards or otherwise pony up enough money to keep flipping without any interruptions.
Put simply, through the power of alternative investment structures not offered by financial institutions or other businesses. A popular type of financing for relatively short-term real estate flips is called hard money loans.
Unlike obtaining mortgages or loans through traditional financial institutions, hard money loans are typically provided to private investors’ most trusted and promising flip artists. Banks require things like bank statements, tax returns, forms of identification, credit scores, and tons of other financially-relevant information so plain-Jane, old-school financial institutions can enter your information into algorithms and computerized tools to determine if you’re a good fit for loans.
Let’s pin the tail of explanation on the donkey of hard money loans!
Note: no animals were harmed during the writing of this entry.
As you know, all fields related to finance have a fair-sized glossary of jargon and complex terms. Two of these terms are hard money and soft money.
The following are all characteristics of hard money loans:
- Hard money loans feature real estate as collateral; such pieces of realty cannot be occupied by the owner or the person who accepted the hard money loan.
- Hard money isalmost always linked to higher interest rates than other loans.
- These unconventional financing agreements work with real estate flippers’ needs in mind, only charging interest payments each month and deferring all principal payback requirements until the very end in the form of a balloon payment.222
Keep in mind that some hard money loan lenders only accept certain classes of real estate as collateral; investors simply can’t do well with certain plots of land, houses, and other variables – even if those particular variables would work well for most people.
There’s one more thing about hard money loans in the United States
All 50 states have legislation against providing hard money loans to borrowers whose collateral is the house that they’re currently living in. As you can tell, these owner-occupied houses – that’s what they’re usually referred to in such situations involving improper hard money loans – because they effectively act as mortgages.
Financial institutions that wish to engage in the servicing of mortgages have to successfully handle a slew of regulatory stew; hard money loans are provided by individuals or – more commonly – by small groups of investors, all but ruling them out of being able to adhere to the aforementioned slew of regulations.