When it comes to getting a loan, there are a lot of options available to you. You can go the traditional route and get a loan from a bank, or you can explore alternative options such as hard money loans. A hard money loan is a type of loan that is backed by real estate which makes them less restrictive and more lenient when it comes to qualifications than traditional loans.
However, there are some things you should know before taking out a hard money loan in California. Here are six of them!
The interest rates
Because hard money loans are less regulated, they typically come with higher interest rates than traditional loans. So before you take out a hard money loan, make sure you understand the interest rate and are comfortable with it.
For instance, let’s say you borrow $100,000 for a property at 10% interest. This means that you’ll owe the lender $110,000 – the original $100,000 plus 10% interest. Therefore, when looking for hard money lenders in California, it’s important to compare interest rates to ensure you’re getting the best deal. Very often, the difference in interest rates can mean thousands of dollars in savings over the life of the loan.
Additionally, interest rates on hard money loans are often variable, so make sure you understand how the interest rate can change over time and what that means for your monthly payments.
The fees
In addition to higher interest rates, hard money loans also come with a variety of fees. These can include an origination fee (which is typically 2-5% of the loan amount), a points fee (1-10 points, or 1-10% of the loan amount), a due diligence fee (to cover the lender’s costs in researching the property and your financial history), a processing fee, and more.
Points fee and origination fee are sometimes used interchangeably, but they are two different things. Origination points are a one-time fee paid to the lender at closing, while points are a percentage of the loan amount that is paid upfront.
So if you’re taking out a $100,000 hard money loan with 5% origination points and 10 points, you’ll owe the lender $5,000 upfront for the origination points, plus an additional $10,000 – 10% of the loan amount – for the points fee. That’s a total of $15,000 in fees!
Additionally, these fees are often rolled into the loan amount, so make sure you understand how they will affect your total loan amount and monthly payments.
The repayment schedule
Hard money loans typically have a shorter repayment schedule than traditional loans – usually 12 months or less. This means that you’ll need to be prepared to repay the loan in a relatively short period.
Additionally, hard money loans often have what’s called a balloon payment, which is a lump sum payment that is due at the end of the loan term. This can often be the entire loan amount plus interest and fees, so make sure you understand how much the balloon payment will be and whether you’ll be able to afford it.
However, the upside of the shorter repayment schedule is that you can often get the money you need fast – often in as little as a few days. So if you’re in a bind and need cash quickly, a hard money loan might be the best option for you.
The equity requirements
Most hard money lenders will require that you have at least 20-30% equity in the property you’re using as collateral for the loan. So if you’re borrowing $100,000 against a property worth $200,000, you have 50% equity in the property.
If you don’t have enough equity in the property, the lender may require that you put down a larger down payment or find another piece of real estate to use as collateral.
Also, keep in mind that the loan-to-value ratio (LTV) – the amount you’re borrowing divided by the value of the property – will affect the interest rate and fees you’re charged. The higher the LTV, the riskier the loan is for the lender and the higher the interest rate and fees will be.
The loan purpose
Before taking out a hard money loan, make sure you understand what the loan can and cannot be used for. Hard money loans can be used for a variety of purposes, including but not limited to:
- Fix-and-flip investments
- Construction projects
- Bridge loans
- Refinance/cash-out loans
In general, hard money loans cannot be used for personal expenses or to purchase a primary residence. This is because hard money loans are secured by real estate, so the property you’re using as collateral for the loan is at risk if you default on the loan. That’s why it’s important to make sure you can afford the monthly payments and that you already have a property you can use as collateral.
On the other hand, traditional loans – such as a home equity loan or line of credit – can be used for just about anything, including personal expenses.
The exit strategy
Before taking out a hard money loan, you should have an exit strategy in place. That is, you should know how and when you’re going to repay the loan. Will you sell the property? Refinance it with a traditional loan? Or do you have another source of funding?
For instance, let’s say you’re taking out a hard money loan to finance a fix-and-flip investment. You should have a plan in place for how you’re going to sell the property and repay the loan, such as finding a buyer before you even start the repairs or listing the property with a real estate agent.
If you don’t have an exit strategy, you could end up defaulting on the loan and losing the property. So make sure you have a plan in place before taking out a hard money loan.
Hard money loans can be a great option when you need fast, easy access to cash. They come with fewer restrictions than traditional loans and often have a shorter repayment schedule.
However, there are some things you should know before taking out a hard money loan in California. Make sure you understand the terms of the loan, including the equity requirements, repayment schedule, and purpose of the loan. And most importantly, have an exit strategy in place so you know how and when you’re going to repay the loan.
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