What is a Hard Money Loan?
How Does a Hard Money Loan Work?
A hard money loan provides money for short-term expenses similar to a bridge loan. A hard money lender provides the loan as long as the borrower is willing to pledge a piece of real property as collateral against any default.
A common example of a hard money loan is a car title loan. In this case, the value of the car serves as the basis for the loan amount instead of a credit score. For this reason, highly solvent individuals and alternative lenders (and not banks) can make hard money loans to people with poor credit who are otherwise unable to secure a similar loan from a bank.
For example, suppose Bob needs money to cover his monthly bills until he receives his next paycheck. Due to his poor credit history, his loan application is rejected by several traditional lenders. Though Bob doesn't have strong cash flow, he does have $110,000 of equity in his home, so he approaches an independent investor who agrees to give Bob a hard money loan of up to $50,000 in return for pledging his home as collateral.
Why Does a Hard Money Loan Matter?
Hard money lenders assume high levels of risk and frequently charge high interest on hard money loans. It is important not to confuse hard money loans with home equity loans, which are made only by banks on the basis of home value combined with satisfactory credit.