What Collateral is Required for a Hard Money Loan?

Before you can get approved for a hard money loan, you need to put up collateral. In this post we discuss the types of collateral required to secure a hard money loan.

The two types of collateral needed for a hard money loan are:

  • Cash collateral
  • Real estate bought with the loan

If you’re shopping for a hard money lender check out our directory of hard money lenders by state.

Cash Collateral Required for a Hard Money Loan

Hard money lenders generally require you to put up anywhere from 10-20% of the Loan-to-Value (LTV) amount in cash.

For example, if the propery is worth $100,000 in its current condition, a hard money lender may be willing to loan 90% of that. You will be required to put up the remaining 10% or $10,000.

Hard money lenders will rarely loan up to 100% LTV. Transaction costs and market liquidity will eat up the lender’s ability to recover its money by selling the property if you default.

Collateral Required Varies

Like any lenders, hard money lenders risk their capital based on the economics of a property deal. The difference between a hard money lender and a traditional mortgage lender is that hard money lenders rely strictly on the collateral value when deciding how much to lend. There is no consideration of the borrower’s creditworthiness or credit history.

Standard Buy-and-Flip Hard Money Loans

In a standard buy-and-flip situation, the lender will generally consider the property’s current market value to determine the collateral amount.

However, if the buyer brings evidence of tangible buyer interest, such as a signed wholesale purchase contract, then the lender may reduce the collateral amount required. In this case, the financing is used as a bridge loan with a known buyer in mind. This is considered a “quick win” by both the lender and house flipper.

Hard Money Loans for Fixer-Upper and Property Improvement Projects

Borrowers that have a clear and logical plan to fix up a property in need of repairs, or expand a property to move it up-market, can often negotiate a lower loan-to-value ratio.

If a borrower can prove the project has a higher economic value than the current property value, this offers a hard money lender two benefits:

First, the loan term is normally longer, earning the lender more interest. it takes more time to fix and improve a property, then market it, than a simple flip. So the lender can earn more interest over a longer period.

Second, if the loan proceeds are used to improve the property, the resulting real estate collateral value should rise quickly. This makes the loan inherently more secure. The key here is the rehab / improvement project must be well-planned and executed.

Where renovation or improvement work is required, a hard money loan will typically be structered as a purchase loan plus a construction loan. To do this, the borrower needs to present a property improvement plan that clearly shows the timeline, permits, investment required, and expected market value after improvements (aka After Repair Value or ARV).

In these types of deals the lender will typically require a smaller amount of cash collateral up-front to buy the property. The construction project is funded separately. The construction funds are released in stages as each phase of the work is completed successfully.

Why Hard Money Collateral Quality Is Critical

In the case of hard money loans, lenders consider the real estate securing the loan to be the most important collateral. The cash downpayment is just “skin in the game”.

So before you apply for this loan, you must understand the value of the property you are ready to pledge. The lender doesn’t care about your promises or ability to repay the loan. They emphasize the value of the real estate collateral so that if you default, they can quickly sell the collateral. 

Naturally, hard money lenders want high-quality marketable real estate as collateral. The higher the marketability of a property, the more negotiating power the borrower has as far as interest rate and terms.

As a result, hard money loans used to improve and flip properties in rising markets on the good side of town will cost less and get approved more readily.

Houses that require substantial rehab, properties located in less-than-ideal places, and weak housing markets all increase the required cash collateral. These factors also cause the lender to charge higher interest rates and foreclose faster.

LTV Is Never Greater Than 100%

It’s seldom (if ever) that you will find a hard money lender willing to lend at more than 100% LTV. This important to consider if you have multiple properties and you want to use income from another property to support your loan application. In that case, a more traditional commercial real estate loan might be a better choice.

Beware of Hard Money Loan Risks

When considering a hard money loan to fund a property transaction or rehab project, make sure your projected sale price will cover the carrying cost of the loan, any improvements, and transaction costs.

Emergencies and construction project failures can happen. An unknown lien holder can come out of the woodwork. Your contractors can fail to show up on time. The project can suffer theft or vandalism damage.

You need to be a strategic borrower when using hard money loans. The loan structure rarely has flexibility built-in so it’s important to risk only the cash collateral you can afford to lose in a worst-case situation.

If the Economics Are Right Hard Money Loans Are a Solid Choice

When applying for a hard money loan, you don’t need to leverage your creditworthiness. Lenders will not do background checks and they will not base the loan on your credit history. All they care about is the value of the cash and property collateral you pledge.

This means you can quickly fund a flip property deal or rehab project with significant upside.

If the economics line up and you’ve got the required hard money collateral, then hard money loans are a solid choice.

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