Every type of loan is governed by some sort of repayment structure. It made sense to understand that structure before signing loan documents. Better yet, a good understanding of how a loan is repaid could influence whether a borrower bothers to apply. Hard money is perfect for illustrating the point.
Hard money is provided by private lenders like Salt Lake City’s Actium Lending. Actium offers hard money and bridge loans in Utah, Idaho, and Colorado. They advise fully understanding repayment structures, rates and terms, and all other applicable conditions before agreeing to borrow.
With that said, here is what every hard money borrower should know about repayment:
1. Terms Are Very Short
First and foremost is the fact that the terms on hard money loans are very short. Where a traditional lender thinks nothing of lending for 10-30 years, it is rare for a hard money loan to exceed 36 months. Most have terms of 12-24 months. Some can even be as short as 6 months.
Note that this is by design. Hard money loans are riskier than their traditional counterparts. One of the ways lenders manage risk is to keep terms short.
2. Monthly Payments
Although there are exceptions to the rule, most hard money loans are structured as interest-only loans. That means the borrower only pays interest with his month-to-month installments. This keeps monthly payments more manageable. However, it comes at a price. That price is the very next point in this post.
3. The Balloon Payment
The final monthly payment a lender makes is known as a ‘balloon’ payment because it is so much higher than all the payments before and. It is higher because it includes the final interest payment as well as the full amount of principal.
With a traditional mortgage, the principal amount is slowly reduced with each monthly payment. You eventually get to the point where you are paying more towards the principal than interest. Throughout the entire life of the loan, monthly payments remain static.
With a hard money loan, however, monthly payments typically do not reduce the principal. You pay the principal all at once – with the final payment.
4. Repayment Trigger
Hard money loan repayment is a bit different in the sense that something triggers it. For example, imagine a real estate investor approaching Actium Lending for a hard money loan to purchase a piece of commercial property. The borrower’s exit strategy is quite simple: he will arrange traditional financing after closing. That financing will cover the hard money loan.
Obtaining traditional financing triggers the final hard money loan payment. Some lenders, Actium included, do not assess an early repayment penalty. As long as the borrower repays the principal and the total amount of interest the two parties agreed to, the loan can be paid off as soon as the borrower obtains traditional financing.
5. Higher Interest Rates Aren’t All Bad
Let’s finish up by addressing interest rates. What do they have to do with repayment? Everything, when you consider how terms impact the total interest paid. A term of 10 years will result in more total interest paid compared to a loan with a term of just 2 years. So even though interest rates on hard money loans tend to be higher, shorter terms still mean less total interest paid – at least in most cases.
If you are thinking about obtaining a hard money loan, be sure you understand the repayment structure before you sign. Be sure you know exactly what you are getting into, just as you would with any other type of loan.