Hard-money loans are a viable option for real estate investors looking for financing, but they do not get utilized nearly enough. They are often a better solution than conventional loans (like bank loans), especially for those looking to flip houses or have a quick turnaround.
Hard-money loans are based on collateral rather than creditworthiness. These loans have qualities that make them favorable for home investors, but they also pose several challenges.
They're typically more expensive because they are more risky. Lenders also demand a personal guarantee in case there are limited assets available for collateral. To tackle the risks, ensure you deal with an experienced and reliable lender to save yourself from any trouble later down the line.
In this article, we will delve into the 10 important terms that every investor should be familiar with when applying for a hard money loan.
10 Terms You Need To KnowLoan-to-Value Ratio (LTV)
This ratio compares the loan amount to the property value (often collateral). A lower LTV indicates a smaller loan compared to the property’s worth, or in other words it measures your financial leverage in the investment.After-Repair Value (ARV)
After-repair value (ARV) estimates the property’s value after renovations. This value is used by lenders to determine an accurate loan amount. The loan value is a percentage of the potential post-repair value.Points
Some upfront fees are charged by the lender, which are called points. Each point equals 1% of the loan amount. When you take a hard money loan, be mindful of how the points impact your total borrowing costs.Interest Rate
The interest rate is the cost of borrowing. Interest rates for hard money loans are typically higher than for conventional loans. As an investor, knowing the difference in interest rates is important for evaluating your total loan expenses.Loan Term
The loan term refers to the duration of the loan. Hard-money loans are often short-term, from 6 months to 3 years. Borrowers should align the loan term with their project timelines and financial capabilities.Prepayment Penalty
Some hard money loans have a prepayment penalty - a fee you have to pay if you repay the loan before the agreed term. Be sure to take the prepayment penalty into consideration if you're planning on repaying the loan earlier than the due date.Default
Default occurs when the borrower fails to repay the loan. Understanding default conditions can help investors alleviate risk, and maintain a healthy relationship with the lenders.Collateral
Collateral is the property or asset that the borrower uses to secure the loan. It is often the basis for the loan, so investors should know what type of collateral is required and its impact on the hard money loan terms.Loan-to-Cost Ratio (LTC)
LTC compares the loan amount to the acquisition and development costs of the property. The loan amount should sufficiently cover the acquisition and renovation expenses.Debt Service Coverage Ratio (DSCR)
DSCR measures the property’s ability to generate income to repay the debt. Lenders use this ratio to assess the financial viability of the project. Understanding DSCR helps investors ensure that their properties meet the lenders’ demands, and a higher number means a more financially stable investment.
In conclusion, mastering the intricacies of these key terms associated with hard money loans is not just a matter of industry jargon; it's a strategic imperative for real estate investors. A firm grasp of concepts like Loan-to-Value Ratio (LTV), After-Repair Value (ARV), Points, Interest Rate, Loan Term, Prepayment Penalty, Default, Collateral, Loan-to-Cost Ratio (LTC), and Debt Service Coverage Ratio (DSCR) serves as a compass, guiding investors through the labyrinth of financing decisions.
At RCN Capital, we offer financing to real estate professionals, commercial contractors, and developers across the nation. We provide short-term fix & flip financing, long-term rental financing, and new construction financing for real estate investors. If you are an investor looking to acquire a hard money loan, RCN Capital has competitive loan options available.