Private money lenders are companies funded through private investment or equity. They aren’t banks and don’t operate under a bank’s charter, instead; they exist to fill the gaps in the marketplace between a bank’s strict lending requirements and borrower demand. These lenders are a great resource for home buyers who, for various reasons, might not qualify for a bank loan.
There are two types of owner-occupied hard money loans, a consumer bridge loan, and a long-term private loan. Before applying, make sure you understand the differences between them and the pros and cons of using a hard money lender to buy an owner-occupied property.
Consumer Bridge Loan
A consumer bridge loan from a hard money lender bridges the gap between when you want to buy a property and when you can qualify for a traditional mortgage. It’s best used when you have short-term issues that prevent you from borrowing now but will clear up in a few months to a year.
Common reasons that a borrower might need a consumer bridge loan include if you want to buy now but still have a home to sell. A traditional lender is unlikely to approve you for two mortgages, so you can go to a hard money lender for financing and then refinance out of their loan when your first property sells. This is also common during divorce and probate proceedings.
Short-term issues that will fall off your credit report within the bridge loan’s term, such as a bankruptcy, foreclosure, or short sale, are also good reasons to seek a bridge loan. These loans are short term and rarely have terms longer than a year. They also carry high interest rates, which reflect the lender’s risk, of 10% and up. And lenders will ask you to pay interest of 2-3% upfront to offset their risk.
Long-Term Private Loans
Because of regulatory changes, the only private money long-term mortgage that hard money lenders can offer is a 30/30 loan. The loan must be fully amortized over a 30-year term.
You can use these loans to buy a home if your credit issues won’t resolve within 12 months. They’re also good for individuals who are self-employed or have trouble documenting income, or inconsistent income history. If you’ve gone through a long period of unemployment, even if you still have a decent credit score and are employed now, they might be your only option.
Like bridge loans, long-term private loans charge high interest rates and require that you pay interest up-front. Expect rates of 9% and up, and points of 2-3%.
Qualifying for a Hard Money Loan
When underwriting a hard money loan the lender will primarily be concerned with your income and the property’s value.
They will verify your income through a third-party. They want to know that you can repay their loan. The amount of equity you have in the home after closing, and its total value, will also be important to them as your home serves as the loan’s collateral. Loan-to-value, or the amount you’re borrowing divided by the home’s value, is an important metric used when approving or denying a hard money loan.
Hard money lenders may require larger down payments than a traditional lender, and since the loan is a high-cost loan, they will collect both property taxes and homeowners insurance for the first year at closing.
Pros and Cons of Hard Money Loans
Hard money loans cost more than a traditional loan. As a buyer, you’ll need more money up front to get into the house. Expect to pay more fees and higher interest rates, and interest up front.
Another downside to a consumer bridge loan is that if the issues that prevented you from qualifying for a traditional mortgage don’t clear up before the loan ends, you could be in big trouble. The loan will come due and, if you can’t refinance or qualify for another bridge loan, you could lose your home. Your buyer’s agent can walk you through several worst-case scenarios to make sure you’re prepared and understand the risk.
A borrower should only go to a hard money lender for financing if they have been denied by a bank or know they won’t be approved for a mortgage. Given their high cost, and the risks involved, you might be wiser to wait until you can qualify for a traditional mortgage.
A Clever Partner Agent can help buyers get a great deal on your home no matter how you finance it. They work for less commission and offer home buyer’s rebates where allowed. You could use your home buyer’s rebate to pay for closing costs. If you’re ready to talk to a Clever Partner Agent, reach out to be connected with one today.