You can get a hard money loan even if you have bad credit. Your credit score usually isn’t something hard money lenders look for. They’re more interested in things like your tangible assets (e.g., real estate equity) and your loan-to-value (LTV) ratio, as opposed to credit history and prior bankruptcies or foreclosures, which could prevent you from getting a traditional loan.
However, just because you can get a hard money loan with bad credit doesn’t mean you should. Hard money loans are short-term loans with high interest rates that are great for investment properties, but not necessarily for a primary residence.
In this post, I will discuss:
Let’s get started with this post.
When Should You Get A Hard Money Loan (Even With Bad Credit)
Unlike conventional lenders, who charge lower interest rates and are interested in slowly making a profit over time, hard money lenders are looking to make some fast cash—and in many cases, so are you. Hard money loans typically last 3 - 36 months, and at an average interest rate of 11% - 13%.
Here are a few occasions when you should get a hard money loan, even when you have less-than-stellar credit.
Buying An Investment Property
Whether you’re looking to purchase a beach house to put on AirBnB or a commercial property to give your business a brick-and-mortar home, hard money loans can help. If you have a solid plan, but lack the credit score for a traditional loan (or can’t get one due to their strict requirements), getting a hard money loan can get you the financing you need to get you up and running.
Also, if the loan amount you need exceeds traditional commercial loan limits, a hard money loan, a combination of hard money and working with private investors may be your only option.
Fixing And Flipping A Property
An experienced real estate investor doesn’t need good credit. They need the skills required to identify a fixer upper with potential, renovate it, and resell it for a huge profit. Since these investors are in it for the short haul anyway, they don’t need a long-term loan. Usually a hard money loan of 12 months or less will do. Also, a high interest rate isn’t too much of a concern, because they won’t lose too much of your profits due to interest, anyway.
For example, if you take out a hard money loan of $100,000 at 12% interest and resell it for $200,000 six months later, here’s how you’d fair:
$200,000 - $100,000 (loan amount) - $6,000 (interest) = $94,000
This example doesn’t account for renovations or seller’s costs, but even if they amounted to $24,000, you’re still making a $70,000 profit for 6 months worth of work.
When Your Credit Is Going To Improve
Nothing stains your credit score forever. If you filed for Chapter 7 bankruptcy, it will fall off your credit report ten years from the date you filed for bankruptcy—sometimes even sooner. If you filed for Chapter 13 bankruptcy or were sent to collections, those drop off your credit report after seven years. While the score increase varies greatly, many people report their credit score increased between 30 and 100 points after a bankruptcy was removed from their credit report.
Let’s say your credit score is 590, partially because you filed for Chapter 13 a little more than six years ago. You’ve got less than a year before your credit score improves, but you found the perfect home, you have strong cash reserves, and a great price during a buyer’s market. It probably won’t be on the market a year from now.
If you’re looking to buy a house, the minimum credit score for a conventional loan is 620. Even if your credit score only increased by 30 points, you’ll be at the minimum in less than a year, and money isn’t a huge concern for you right now.
In this scenario, your options are to either wait another year and hope you’ll find another home to your liking, or to get a residential hard money loan and then refinance when your credit improves. Your interest rates will be high until you can refinance, but if you really want to buy a home, it’ll probably be worth it in the end.
Let’s assume you’re going to take out a 12 month hard money loan (in this scenario, you’re guaranteed to refinance and switch to a conventional mortgage at the end of 12 months) of $200,000 at 12% for 12 months.
While you have a hard money loan, you’ll end up paying $2,000/mo in interest, or $24,000 for the year. It’s a lot of money, but when you refinance with a bank or credit union, you can secure a conventional loan at 4% interest. Even if you refinance back up to $200,000, you’ll only pay $666.67 a month, or $8,000 for the year. You’re losing a lot of money due to interest in your first year, but once you secure a conventional loan, you’ll enjoy the home you wanted at a more typical homeowner’s rate.
When You Shouldn’t Get A Hard Money Loan With Bad Credit
Short answer: If you don’t fit into one of the three categories above, you probably shouldn’t take out a hard money loan. Instead, you should focus on improving your credit, which I’ll talk about a little later.
Even if you fit into one of the above categories, you shouldn’t get a hard money loan if you don’t know if you can pay it back or if the risks make you uneasy. If you default on this loan, your hard money lender can legally assume your loan collateral to recoup their losses. Then, not only do you have poor credit, but you’ve also lost an asset(s).
What Do Hard Money Lenders Look For?
Mostly, hard money loans require tangible value in the form of assets. To make a quick return on their investment, a hard money lender wants to know that the value of the real estate investment can cover the loan. In other words, they’re interested in the loan-to-value (LTV) ratio.
Here’s how LTV works:
Let’s assume you need hard money lending in the amount of $100,000 for a fixer upper, but know that you can sell it for $200,000, the property’s after-repair value (APR). To determine LTV, you simply need to divide the loan amount by the after-repair value (ARV). In this case, your LTV ratio is $100,000/$200,000, or 50%.
While the percentage differs depending on who you work with, most hard money lenders prefer an LTV ratio of 70% or less. If something goes wrong with your fixer upper and you end up defaulting on your loan, they need to know that they can make good on their investment. An LTV ratio of 70% or less also discourages borrowers from walking away if things get tough.
Other factors related to LTV ratios that may appear on a hard money loan application include:
All this information will help your lender decide whether to approve your loan.
Some hard money lender will look at a borrower’s credit score. Even if they do, a credit check doesn’t carry the same weight for hard money lenders as traditional lenders. Also, since many hard money lenders are mostly interested in your LTV ratio, the hard money approval process goes quickly—sometimes taking just a few days!
The Minimum Credit Scores For Conventional Loans
Most people don’t turn to hard money loans right away. Originally, hard money loans were considered a “loan of last resort.” Since then, real estate investors have discovered these loans’ amazing benefits.
If you’re looking to buy a home to live, traditional financing is usually the way to go. Here are the minimum credit scores required for each loan type if you want to work with a traditional lender:
Credit Score Requirements
A credit union or traditional bank loan not insured by a government agency.
The Federal Housing Administration (FHA) insures these loans.
Loans meant for veterans, active-duty military members, and surviving spouses. The U.S. Department of Veterans Affairs guarantees these loans.
Loans backed by the U.S. Department of Agriculture
Loans that exceed conventional loan-servicing limits ($647,200 for a single-family home, except in high-cost markets)
*The minimum credit score for an FHA loan is 580 if you only put 3.5% down. If you have at least 10% of your down payment, your minimum credit score drops to 500.
What Constitutes A Bad Credit Score?
Credit scores range from 300-850. To qualify for the best mortgage rates with traditional lenders, you should have “exceptional” or “very good” credit. Here are the score ranges and what they constitute:
How To Improve Your Credit
If your credit is bad, but you’re interested in getting a conventional loan, or starting with a hard money lender and then switching to a traditional one, here are a few things you should know about how credit works.
Your Credit Score Is Determined By 5 Elements
Here are your credit score’s five determining factors, according to Experian:
How often do you pay bills on time, are late, or have missed payments?
Credit Utilization Rate
How much available credit you have, and how much of it you’re using?
How long have you been using credit?
How many credit accounts have you opened and how many forms of credit have you applied for?
How much and how many types of credit are you using?
Lower Your Credit Utilization Rate
Experian recommends keeping your credit utilization rate under 30%. In other words, if you have $10,000 in credit card limits, keep the total amount of credit owed under $3,000.
Pay Your Credit Cards Every Month
Ideally, you should pay your credit cards in full every month. However, that’s not always possible. If it isn’t, pay as much as possible. If you think hard money loans have high interest rates, you probably haven’t been paying close enough attention to your credit card statements!
Try to avoid minimum payments, as tempting as that may be.
Don’t Apply For More Credit
Applying for a credit card or loan can adversely impact your credit score. If your goal is to improve your credit, getting more of it isn’t the answer.
If you want to purchase a rental property or other form of investment property, hard money financing is probably your best bet. While traditional loans are meant for long-term borrowers, there are special situations where getting a hard money loan can help you get the home you want. Either way, your credit history usually isn’t a factor.Does your hard money lender refer to themselves as a private money lender? You may think they’re the same, but they’re not. Discover the difference between hard money lenders and private money lenders.