Your hard money loan’s interest rates seriously impact the amount you have to pay back. The average hard money loan rates in 2020 were between 11% and 13%. In 2021, those numbers varied between around 7.5% and 15%.
If you take out a one year loan for $100,000, you’ll spend $7,500 in interest at 7.5%, and $15,000 at 15%. If your short-term loan will only last for a few months, worrying about interest rates may not be your top concern. However, if you want a short-term loan for a couple years, a higher interest rate can cost you tens of thousands of dollars.Hard money loans are short-term loans ideal for:
The trade-off is that you’re putting up tangible assets as collateral, and usually paying a much higher interest rate. Tangible assets aren’t negotiable, but your interest rate is.
In this post, I will discuss:
Let’s get started with this post.
Why Hard Money Interest Rates Are So High
Your interest rate is the amount your lender charges you, in addition to the principal, which is the amount of your loan. It’s how banks and hard money lenders make a profit on their investment in you.
Traditional lenders, such as banks and credit unions, are more interested in long-term loans, which are repaid in 15, 20, or 30 years. Usually, the longer your loan term is, the lower the interest rate will be. Lower interest rates equate to a lower barrier of entry for home buyers, while still allowing banks to make a huge profit. Here’s how:
Let’s say you’re taking out a $250,000 loan for 30 years with a 4% interest rate. 4% doesn’t sound like a lot, right?
As it turns out, by the time you pay interest off your loan, you will have paid $179,673.77!
Also, for the first 13 years of your loan, you’re paying more in interest than on your principal balance. In other words, paying the bank more for the additional amount they’re charging you than for the actual cost of your home. You don’t even pay off ½ of your home’s purchase price ($125,000) until year 20!
A hard money lender doesn't have the advantage of longevity. These loan periods are typically just 3 - 36 months, so charging higher interest rates is usually the only way their investment in you is worth it for them. Also, higher interest payments inspire borrowers to repay their loan faster, if/when they can.
While a hard money lender makes a larger immediate return, they won’t make anywhere near what a traditional mortgage lender makes from your loan.
Let’s say you’re taking out that same $250,000 loan, but for two years with a 12% interest rate:
You’re only paying $32,440.83 for your investment. That’s still a lot for two years, but nowhere near the $179,673.77 of interest you’ll spend with a conventional loan.
When High Interest Rates Don’t Really Matter
Ultimately, it comes down to perspective. Interest rates on hard money loans always matter to a degree. However, in some cases, your rate is less important than other aspects of your loan. Here are a few examples.
Transactional funding allows real estate investors to buy a property—sometimes without having to use their own funds. This is a very short-term loan, usually somewhere between 24 hours and five days. In some cases, there may not even be an interest rate, unless you’re unable to repay the loan by the agreed upon date. Often, you’ll end up paying a loan application fee and points (points usually equate to percentage points on your loan: one point = 1%, two points = 2%, etc.).
A bridge loan is a short-term loan that covers a financing gap. You may need one when you’re trying to simultaneously buy and sell a home. These transitions aren’t always seamless. For example, you may have to buy a new home before your closing process is complete on the home you’re selling.
If you close on your new home on May 1st, but won’t receive the money from your current home until June 1st, you won’t likely be too upset if your interest rate is a couple points higher. Spending a few hundred dollars extra will help you complete your simultaneous buy/sell transition.
Quick Fix And Flippers
Experienced real estate investors usually have a good idea how long it will take to flip a home. If you find a real estate property you know you can purchase, renovate, and sell for a huge profit in just a few months, a higher rate on a loan for house flipping may not bother you.
For example, let’s say you find a fixer upper on the market for $120,000, and as a savvy real estate investor, you know it’ll cost you $20,000 to fix it up and resell for $200,000 in four months. Before paying interest, your real estate agents’ cost, and other fees, that’s a $60,000 profit! If your down payment is $20,000 and your hard money loan is $100,000, it won’t make a huge difference if your interest rate is 8% or 12%.
Here’s a visual to help:
Total End Profit
Hard Money Loan
12% Interest Rate
($100,000 / 12mos = $12,000
($12,000 / 4mos = $3,000)
8% Interest Rate
($100,000 / 8mos = $3,000
($8,000 / 4mos = $2,000)
Despite the 12% hard money loan being 4% higher, you’ll only spend an extra $1,000 when paying off the loan. That’s not a lot, considering your profit margin for four months of work.
Quick Construction Projects
Similar to quick fix and flippers, construction projects can lead to huge profits. If you take out a hard money loan to purchase land to build a property you intend to rent or sell, you can easily make a quick return on your investment—and then some!
If you buy a plot of land for $100,000, spend $300,000 on construction and permits, then sell the property for $600,000, that’s a $200,000 profit. If you spend $2,000 extra in interest, that’s only 1% of your profit.
When High Interest Rates Do Matter
If your project isn’t a quick turnaround or results in a huge profit, negotiating a lower rate is in your best interest. Here’s when it matters most.
Primary Or Secondary Residence
If your hard money loan is for a primary or secondary residence, you’ll likely want a lower interest rate. Usually, you’ll only want hard money financing for a primary residence if you can’t get a traditional loan.
Let’s say you find your dream home, but you have bad credit because you filed for Chapter 13 bankruptcy five years ago. Your credit score will significantly improve in two years when the bankruptcy drops off your credit report. However, that’s two years away and you want to buy now.
Most hard money lenders don’t care if you have bad credit; they’re more interested in your loan-to-value ratio (LTV). Once your credit improves, you can qualify for traditional financing and switch to a long-term loan at a lower rate.
Until then, the rate of your hard money loan matters. If you’re taking out a $250,000 loan at 12% for two years, you spend $32,440.83 in interest:
If you take out that same loan at 7.5%, your total interest drops to $19,997.56:
That’s a difference of $12,449.27, which is more than $500/mo.
Rental properties take longer to recoup your money simply because you’re not selling them. AirBnBs, VRBOs, and other forms of rentals require you to play the long game. For this reason, you’re likely to need longer loans for rental properties, especially if your sole source of financing is hard money lenders. The two examples above could easily apply to rentals.
Complex Fix And Flippers
As any expert will tell you, real estate investing can be tricky. Not every real estate project goes according to plan. You may encounter supply chain issues, permit or construction delays, or the market may shift between the time you purchase the property and when you’re ready to sell it.
Instead of purchasing a property for $120,000 and selling for $200,000 in four months, you may only get $160,000 for it after eight months. When your profit margin diminishes, every dollar counts. The amount you save on interest could be the difference between making money and losing out on your investment.
Complex Construction Projects
All the issues I just mentioned for complex fix and flippers also apply to construction projects. However, these projects are often done at a greater scale and can take even longer. If your intended start date for construction is delayed six months, those are six extra months during which you’ll pay interest.
The pandemic reminded us that things like this can happen. Negotiating a lower rate can at least minimize your costs.
How To Get A Lower Interest Rate
Hard money loan rates aren’t set in stone. Many hard money lenders have a minimum and maximum rate they’ll charge borrowers, depending on your loan. Here are a few ways to get a lower rate.
Do Your Research And Shop Around
There are no shortage of hard money lenders. In Florida alone, there are hundreds—if not thousands—of hard money lenders available. No matter what state you live in, if you Google “hard money lenders”, you’ll have a seemingly endless number of pages of lender websites to scroll through.
Look for the hard money lenders with the highest ratings, who offer the best rates and terms for what you need. 10 - 15 minutes of research can save you thousands of dollars in the long run.
Improve Your Credit Score
Most hard money lenders don’t require you to have a high credit score, but it certainly doesn’t hurt. Whether they advertise it, some hard money lenders have special programs specific to borrowers they consider more reliable. Like traditional lenders, they may also have a tiered system where the rate you get is linked to your credit score.In some cases, hard money lenders require you to have a decent credit. Groundfloor sometimes offers interest rates that are 2% lower than their competitors, but require you to have a minimum credit score of 600.
Have A Large Down Payment
The main driver for most hard money lenders is your loan-to-value ratio (LTV). To calculate your LTV, you must divide your loan amount by the after-repair value (ARV) of your property or other asset. For example, if you’re taking out a loan for $150,000 and, after renovations, the property’s ARV is $200,000, your LTV is $140,000/$200,000, or 70%. For hard money lenders, the lower your LTV, the safer the investment.
One of the easiest ways to lower your LTV is to have a higher down payment. If you can put $40,000 of your own money down, your loan would be $100,000, and your LTV is then $100,000/$200,000, or 50%. At 50%, you’re much more likely to negotiate a lower interest rate.
Build Your Network And Experience
You’re more reliable on your tenth house flip than your first, and thus easier to invest in. This is especially true if you’re working with the same hard money lender. If a lender knows you're reliable and likely to be a repeat customer, they’ll be more inclined to lower your interest rate.
Similarly, if you’ve developed a good reputation in the real estate investment community, lenders will want to work with you. They might even compete for your business.
Perfect Your Pitch
Imagine you’re on Shark Tank. You’re unlikely to get a good deal if you’re not well-prepared. You need to anticipate the questions hard money lenders will make, such as:
Create an introductory video, a presentation deck, or whatever your visual medium will be while presenting. Include any relevant details, like previous successful projects you’ve worked on, numbers, testimonials, etc.
If you’re planning to flip the property, include the project timeline. If you’re turning it into a rental property, estimate how much you plan to rent it out for, and how quickly you can repay your loan.
Your pitch should paint a clear picture of your plans for the property and how you’re going to implement them. The better the pitch, the more likely you’ll get a lower rate.
Using Private Money As A Hard Money Alternative
Working with a private lender is another option available to you. Private lenders are similar to hard money lenders, except they don’t advertise their services to the general public. Private investors are usually people you know, or people with whom you have a second or third degree connection.
Unlike hard money lenders, private lenders can be anyone: a friend, family member, your real estate agent, etc. They also have a unique interest in your ability to make good on their investment. As such, your relationship with a private investor is more symbiotic.
The terms of your agreement also vary greatly. Unlike hard money lenders, who require collateral and tend to have minimum and maximum interest rate options, the only contractual limits you have with a private investor are the confines of the law. This means that it's possible you can get a better rate with a private lender. It all depends on your terms.
For example, a private lender may be open to giving you a 5% interest rate if they can also receive 10% of your total profit. They may also suggest no interest for the same profit. It all depends on your relationship.
Private lenders are harder to find and can be riskier than working with a hard money lender, but they’re another option worth looking into.
Conclusion: Finding The Right Hard Money LenderFor You
There are many factors to consider when taking out a hard money loan. Of these factors, your loan’s rate is often high on the list, especially if the loan is for:
The longer your loan, the more interest you’ll be paying. By doing your research, improving your credit score, having a larger down payment, building your network and experience, and perfecting your pitch, you’re far more likely to get a better rate. The better the rate, the more you’ll save in the long run.For more information on the options available for flipping houses, check out my post on flip and fix loans. If you’re thinking about simultaneously buying and selling a home, you can also read up on bridge loans.