TRUTH - All hard money lenders are NOT the same. Most of the companies that are advertising hard money loans are only brokers. This means that they don't have their own investors. The question to ask a potential lender is "are your loans funded by your own investors or do you fund your loans through another company?" If you aren't convinced, ask them for five loans they closed last month. It is very easy to get a property profile. When you get the property profile, it will show the lender that actually funded the loan.
Risks in getting a hard money loan
As long as you are working with a credible hard money lender (that is the actual lender), there is no more risk than working with a bank. (ALWAYS read all documents you are signing.)
Things to watch for -
Default rate - Some hard money lenders will put a default rate in a loan. This is similar to a credit card that increases its' interest rate if the payments are not made on time.
Pre-payment penalty - Most hard money loans come with a reasonable pre-pay period. Some loans come with a two or three year penalty period. This is much more than reasonable.
Private money loans (also known as hard money) are very different than conventional
Conventional loans are transacted by banks that have a very strict set of criteria that they are not able to control. Most banks have their loans purchased by Fanniemae or Freddie mac. These two government entities will not purchase a loan unless everything matches their guidelines exactly.
Traditionally, banks lend using the 3 C's: credit, capacity and collateral.
Credit - is the borrower's credit score and payment history.
Capacity - is the borrower's ability to make payments.
Collateral - is the asset that is pledged as security for the loan.
Borrowers that fall short in one of these three areas are not able to get a traditional bank loan. For the past several years it has gotten increasingly more difficult to acquire a bank loan. There are an increasing number of conditions being placed on borrowers in order to qualify with a bank.
Hard money loans (also known as private money) received this nickname because these are loans that are "hard" for a bank to do. A true hard money loan is extremely simple. The main criteria that needs to be met for a hard money loan is the right amount of equity in the property for the situation. The reason these are also called private money loans is because the funds generally come from private investors that are looking for a more secure investment than the stock market can offer.
What aspects will effect a hard money loan?
LTV (Loan To Value) - which is the loan size compared to the value of the property. The higher the LTV, the higher the risk is for the investor. As the risk factor goes up, the investor wants a higher reward.
Location - Just like in all Real Estate situations, location is (almost) everything. A ranch on 100 acres in the middle of the desert isn't going to be as easy to sell as a standard home in a nice neighborhood.
Condition - Even if the home is in a nice neighborhood, if it's falling down, that will effect the security of the loan. Once again, this will not stop a true hard money lender from doing a loan. This will just effect the amount a lender is willing to lend.
Property type - Everything that has value is open to a hard money loan, but there is a difference. It comes back down to the investor's security. A traditional home is easier to sell on the open market than a gas station. If the borrower gets into trouble and needs to sell their property, it's a much more difficult prospect on a unique property than on a Single Family Residence (also know as a SFR).
Credit - The reason this is at the bottom of the list is because absolutely terrible credit should never stop a true hard money lender from lending money to a borrower. Credit can still affect the comfort level of an investor. If a borrower has very good credit, an investor may be willing to invest at a lower interest rate than someone with very low scores.