Hard money is a form of private lending utilized by investors and businesses. It is an alternative to traditional bank financing when financial institutions will not touch high-risk projects. And yes, hard money lending has its own vocabulary. It is important to know that vocabulary before going in.
If you compared hard money lending to a sport, you would see there are unique rules defining how the game is played. Many of the rules of hard money lending are encapsulated in its vocabulary terms. That leads us back to the original point of knowing the terms upfront.
Below are some of the terms hard money borrowers need to be aware of, compliments of Salt Lake City’s Actium Partners. Actium specializes in hard money and bridge loans in Utah, Idaho, and Colorado.
Term #1: Hard Money
Let us start with hard money itself. Hard money is defined as private money lent by private investors rather than banks or credit unions. It is designated as ‘hard’ because lenders require borrowers back their loan requests with hard assets used as collateral. More often than not, collateral is a piece of real property.
Term #2: Collateral
Collateral is some type of asset that is put up as backing for a loan. It is understood that collateral will be seized and sold to pay for a loan that is allowed to go into default. Loans intended to cover real estate transactions tend to be back by the very properties being acquired.
Term #3: Interest-Only Payments
Hard money loans tend to be structured as interest-only payments. What does this mean? It means monthly payments cover interest charges only. Borrowers do not pay the actual amount borrowed (a.k.a. the principal) until loan maturity.
Term #4: Balloon Payments
Though not every hard money lender utilizes the term ‘balloon payment’, many do. A balloon payment is essentially the final payment made on an outstanding loan. It covers the loan principal, the very last interest payment, and any other fees not yet paid by the borrower. A balloon payment is the largest single payment a hard money borrower will pay.
Term #5: Buy-and-Hold
‘Buy-and-hold’ is a term used to describe a certain type of hard money borrower. This is an investor looking to buy property he intends to hold for a longer period of time. Perhaps the investor is buying a strip mall. He plans to hold it as a landlord for 5 to 10 years.
Term #6: Fix-and-Flip Investor
While many hard money borrowers are buy-and-hold investors, others are fix-and-flip investors. They purchase commercial or residential properties in need of repair. After making repairs and upgrades, they put the properties back on the market to sell them as quickly as possible. They make their money by selling at prices higher than their cumulative purchase and rehab costs.
Term #7: After Repair Value
Hard money lenders willing to loan to flippers need to consider after repair value (ARV) when determining how much they are willing to lend. ARV is an estimate of what a property will be worth once all renovations and repairs are complete. Determining ARV is risky because you need to have a feel for where the market could be going 4 to 6 months down the road.
There are other terms relating to hard money lending that are worth learning, especially if you are planning to borrow. The more you know about hard money lending, before you fill out your first loan application, the better off you’ll be. It is always wise to know the rules of the game before you actually play.