Hard money loans represent an alternative form of financing when borrowers either cannot get traditional loans or are not interested in dealing with traditional lenders. Because most people know so little about hard money, firms like Salt Lake City-based Actium Lending get a lot of interesting questions. For example, are hard money loans always interest-only loans?
Actium Lending is active throughout Utah, Colorado, and Idaho. They explain that private lenders generally have the ability to be more flexible compared to traditional financial institutions. That means they can choose to structure loans as interest-only vehicles or follow a more traditional model.
The truth is that most hard money loans are structured as interest-only loans. But exceptions to that rule always exist. A lender and borrower could always work out some sort of deal in which principal payments are included with interest in monthly installments. A more traditional structure is never out of the question.
Why Lenders Have That Flexibility
Private lenders have more flexibility in how they structure hard money loans. That flexibility is rooted in the fact that private lenders are not financial institutions. They are organized as private companies lending directly to borrowers. In some cases, you might even have a single individual acting as a private lender. He has money he wants to lend, so he does.
Flexibility gives private lenders an opportunity to structure loans in whatever way makes the most sense. More often than not, that means an interest-only loan that meets the needs of both borrower and lender.
How Interest-Only Loans Work
The nuts and bolts of an interest-only loan are found in the name itself. An interest-only loan requires monthly payments just like a traditional loan, but the payments cover only the interest. With an interest-only loan, the borrower does not pay the loan’s principal until the final payment date.
By contrast, take a look at your own mortgage. If your mortgage is like most others, your monthly payments go to cover three things:
- Loan interest
- Taxes and insurance
- Loan principle
Also note that amortization adjusts the balance between interest and principle throughout the life of the loan. The more principal you pay, the less interest you are charged. The result is that the amount of your monthly payment that goes toward principal gradually increases while the amount going toward interest decreases commensurately.
Traditional, amortized loans tend to cost more each month because you are paying both interest and principal. By structuring a hard money loan as interest-only, the lender eliminates the principal portion of the payment. The downside is that the borrower must come up with the full principal amount when the loan comes due.
Usually Not a Problem
Real estate investors make up the vast majority of clients who borrow from hard money firms. For them, the interest-only structure is usually not a problem. Lenders like Actium Lending require borrowers to present a reasonable exit plan with their loan applications. The exit plan lays out how a borrower intends to pay off the loan on its maturity date.
A fairly common scenario involves an investor obtaining a hard money loan to acquire a new piece of property. After the fact, he refinances the property with traditional funding. Funds from the new loan are redirected to pay off the hard money loan.
Hard money loans are generally structured as interest-only loans. But when made by private lenders, they do not have to be. Private lenders have a lot more flexibility in loan structure, underwriting, lending criteria, etc. That’s one of the reasons so many investors prefer hard money as a first choice.
