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Mortgage

The Pros and Cons of a Hard Money Loan

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Hard money loans are a way to borrow money outside of traditional mortgage lenders. These loans can help homeowners renovate their property or buy a second home, and real estate investors may find them perfectly suited for fix-and-flip operations. However, hard money loans often have short payoff timetables and higher interest rates, meaning they’re not ideal for every situation.

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How do hard money loans work?

A hard money loan is a short-term loan secured by real estate, not credit. Unlike mortgages, which take a long time to underwrite, hard money loans can be secured quickly — making them a great choice if you’re in need of fast cash. The underwriting standards are typically less strict too because they’re issued through private lenders, not banks or credit unions.

That’s also why most hard money lenders specifically target real estate investors, who want to make quick offers on bargain properties. Some lenders won’t even work with traditional homebuyers, so if you’re looking for a mortgage alternative for an owner-occupied property, this may not be your best bet.

For a hard money loan, “the lender is at liberty to decide the circumstances under which they’re willing to make that loan,” said Tendayi Kapfidze, the chief economist at LendingTree, which owns MagnifyMoney. Each lender establishes its own requirements for credit scores, debt-to-income (DTI) ratios and loan-to-value (LTV) ratios and often, these standards are looser than what traditional mortgage lenders may require.

“Typically, the buyer puts up significant collateral, so if things go astray, the lender can recoup their outlay,” Kapfidze said.

For most types of hard money loans, that collateral is the same: your house. If borrowers default on their loan, the hard money lender will take and sell the home. That makes these loans riskier than standard mortgages.

Unlike traditional mortgages, lenders expect repayment much more quickly. Expect your hard money loan to last between 12 months and five years — but considering the high interest rates, you’ll probably want to pay off your debt as quickly as possible, anyway.

“The biggest difference with hard money loans is the interest rate,” Kapfidze said. “If you’re getting a mortgage backed by Fannie Mae, Freddie Mac or government interest rates, there’s a lower interest rate because of the perceived guarantee. There’s less risk for the lender.”

While the exact interest rate will vary by lender, borrowers may pay up to 15% annual percentage rate (APR), or more.

Hard money loans can help buyers a number of ways. Common loan types include, but are not limited to, the following:

  • Bridge loans, which help buyers “bridge the gap” between the current property they own and the property they hope to buy. A hard money provides short-term financing to help with the down payment and moving cost, which is typically repaid after closing.
  • Fix-and-flip loans, which help potential buyers purchase distressed properties intended for renovation and reselling.
  • Owner-occupied loans, which help consumers with poor or no credit buy a home.

Benefits of hard money loans

With high interest rates, short payment terms and your house on the line, you might be wondering why anyone would want a hard money loan. But there are a number of circumstances well-suited for these unique loans.

“If you’re not able to access a traditional loan, then maybe there’s an opportunity here,” Kapfidze said. For consumers who have difficulty obtaining traditional loans or for projects that don’t conform with traditional lenders’ requirements, a hard money loan may be necessary.

The benefits of a hard money loan are:

  • Speed. Buyers in need of funds fast may choose a hard money loan. Because the underwriting guidelines for hard money lenders are often less strict, and require less documentation, the loan can close quickly.
  • Lenient requirements. Have a low credit score? A tax lien on your house? Are you a foreign national struggling to establish U.S. credit? Underwriting standards for hard money lenders are significantly more lenient than traditional lenders.
  • Flexibility. Many hard money lenders provide funds from their own reserves, allowing them flexibility with the loan’s terms — especially in terms of the repayment timeline. Whether you want to repay the loan in six months or seek a longer-term period, lenders aren’t restricted to pre-established term sheets.
  • Leverage in the real estate market. For flippers hunting down bargain properties, finding fast funding is essential. Quick financing lets them snap up the perfect home for rehab before other buyers do.

Pitfalls of hard money loans

While hard money loans are ideal for a number of circumstances, these borrowed funds can be risky.

“If you’re unable to pay back the loan and you have your property as collateral, your lender has a claim on that property,” Kapfidze said. And while that may also be true with traditional mortgages, the high interest rate and quick payment schedule common among hard money loans might make your monthly payment sky-high.

Some of the major pitfalls of hard money loans include:

  • Higher interest rates. Even if you pay off your loan in full, you’ll end up paying a lot more interest than you would with a standard mortgage. For example, a $50,000 loan with a 15% interest rate and a five-year repayment plan will cost you more than $21,000 over the life of the loan.
  • Shorter terms. Repaying a large loan in five years or fewer means higher monthly payments. Understand how the true costs of your loan fit into your household or business budget before proceeding.
  • Little oversight. Unlike traditional mortgage lenders, hard money lenders experience little government oversight. Borrowers must take care to avoid unethical lenders looking to exploit desperate buyers.

When to consider a hard money lender

Still not sure if a hard money lender is right for you? Here are some circumstances where this loan might be a good fit.

  • You can’t find traditional financing — especially for an investment property. Many hard money loans are designed for real estate investors, not your average buyer looking to purchase an owner-occupied property. In fact, many hard money lenders won’t even lend to consumers. But if you’re looking to renovate an investment property and don’t meet traditional lenders’ requirements, a hard money loan may help you proceed.
  • You need money fast. These loans send funds more rapidly than a traditional lender. If the local real estate market is hot and you need cash quickly, a hard money loan may entice the sellers to choose you.
  • Your credit score is low. Your property serves as collateral for a hard money loan — not your creditworthiness. Buyers with extremely poor credit may not meet the requirements for a traditional loan, making a hard money loan their only choice.

Where to find reputable hard money lenders

A Google search will turn up hundreds of eager hard money lenders, but finding out which ones are reputable and which are not can be difficult. Talk to real estate investors in your area to learn about the best lenders nearby.

Ask any potential lender the following questions:

  • Do you only work with investors? If you’re hoping to use these funds for an owner-occupied property, a hard money lender that works exclusively with real estate investors won’t be a good fit.
  • What is the interest rate? If you don’t see interest rates outlined on the lender’s website, ask directly. You don’t want to be surprised by a high interest rate.
  • How will I repay the loan? Hard money lenders handle repayment in different ways. Some ask for interest-only payments, and some request full repayment at the loan’s end. Others work much like traditional mortgage lenders, with regular monthly payments throughout. Find out what each lender expects so you can be sure the repayment fits within your budget.
  • What fees will I pay? Get a thorough accounting of any fees you might pay, as well as any points you’ll be expected to pay. A “point” is an upfront fee, calculated as a certain percentage of the total loan that lets you lower your interest rate.
  • What happens if I pay the loan off early — or late? Some lenders don’t let you pay a loan’s balance early. And some charge additional fees if you pay any installments late. Know what your lender expects ahead of time.

Risks to look out for

Not everyone who labels themself a “hard money lender” is worth working with. Loan sharks may masquerade as a reputable lender — but their real goal is causing you slow financial pain before stealing your house from under you.

First, check your lender’s license. The Nationwide Multistate Licensing System offers information about licensing requirements for all 50 states, and allows you to search by lender to ensure its validity. Asking for your lender’s license number can help you weed out potential loan sharks, but it’s no guarantee.

Next, look at the interest rate: Each state has regulations limiting how high lenders can set this number. But loan sharks may not shy away from usury — the legal term for charging illegal interest rates. Knowing your state’s legal interest rate limits will help you avoid predatory loans. And pay attention to adjustable rates, too. Sure, the initial rate may be attractive, but soon it may rise dramatically.

Compare your payments amount to the interest. A common feature of subprime loans is a regular payment that doesn’t even cover the accruing interest. Over time, the amount due continues to grow. If regular payments won’t pay off your loan, you’re probably dealing with a shark.

Asking a real estate lawyer to look over your hard money loan contract is the best way to know you’re not being fleeced. And yes, you do need a contract. Don’t accept any money until both you and the lender have signed.

Alternatives to hard money loans

Just because you have poor credit doesn’t mean a hard money loan is your only option. If you’re looking to purchase a house, there are a number of federally regulated mortgage programs that offer lower interest rates and better terms. Consider looking for a loan through the Veterans Administration available for veterans or the Federal Housing Administration, which can help make owning a home affordable.

Other options include:

  • Home equity loans. These loans offer your home’s equity — or the difference between your home’s worth and how much you owe — in cash. Expect an interest rate of 4.5% to 6%, although underwriting standards will be stricter than those of a hard money lender. Home equity loans can help you afford a down payment or the kitchen renovation of your dreams.
  • Home equity line of credit (HELOC). A home equity line of credit works much like a home equity loan, except not all the money is provided up front. Think of it like a credit card: You can take out funds as needed and pay down your balance over time. Keep in mind these loans often have a variable interest rate, which goes up and down in tandem with the nationwide prime rate.
  • Cash-out refinancing. Much like a home equity loan, a cash-out refinance gives you funds equal to your equity — but it also replaces your current mortgage. That means you may end up paying a higher interest rate, depending on the current prime mortgage market.
  • Business line of credit. Plan on making it big as a real estate investor? A business line of credit gives you easy access to quick cash when necessary, helping you purchase affordable properties quickly.

If you need cash fast and don’t have the credit for traditional loans, a hard money loan may suit you, especially if you’re purchasing investment properties. But pay careful attention to the loan’s interest rates and repayment terms. Loan sharks may masquerade as hard money lenders, and signing the contract for one of their loans can leave you underwater. Before taking out a hard money loan, make sure there’s no other, traditional loan that suits your situation.

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Mortgage

Here are the Best Low- or No-Down-Payment Mortgages

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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It’s an often-cited rule of thumb, but you don’t actually need a 20% down payment to get a mortgage. In fact, you can get a home loan with little money down, and even a no-down-payment mortgage.

Assuming you’re financially prepared for all of the other responsibilities of homeownership, consider the following mortgage programs.

No-down-payment mortgage options

USDA loans

The U.S. Department of Agriculture (USDA) insures home loans made by approved lenders to eligible homebuyers in designated rural areas. As the program states, USDA loans were created to improve the quality of life in rural areas by giving families the opportunity to own a “modest, decent, safe and sanitary” home as their primary residence.

There’s no required minimum down payment or mortgage insurance, but there are guarantee fees. A portion of the fee is paid upfront and is 1% of the loan amount; the other portion is 0.35% of the loan amount and is paid annually.

To be eligible, you must:

  • Have a low-to-moderate income for your area
  • Buy a home in a designated rural area
  • Have a preferred minimum 640 credit score
  • Have a maximum 41% debt-to-income (DTI) ratio

VA loans

The U.S. Department of Veterans Affairs (VA) also offers a no-down-payment mortgage option guaranteed through its VA loan program. These loans cater to active-duty military service members, veterans and eligible spouses, and are offered by private lenders.

Borrowers aren’t required to make a down payment, but there is an upfront funding fee — which ranges from 1.4% to 3.6% of the loan amount — to help offset the program’s costs to taxpayers. The loan must be used to purchase a primary residence.

To be eligible, you must:

  • Have a certificate of eligibility from the VA
  • Have a preferred minimum 620 credit score
  • Show proof of stable income
  • Have a maximum 41% DTI ratio

Low-down-payment mortgage options

Fannie Mae HomeReady® and Standard 97% LTV

Fannie Mae has two low down payment conventional loans: HomeReady® and Standard 97% LTV. The HomeReady® mortgage program is open to both first-time and repeat homebuyers, while the Standard option requires at least one borrower to be a first-time buyer.

Borrowers can’t earn more than 80% of their area median income (AMI) if applying for a HomeReady loan. Additionally, if all borrowers on either a HomeReady or Standard loan are first-timers, at least one of them must complete an online homebuyer education course.

Both programs also require private mortgage insurance (PMI) if you make a down payment of less than 20%, though PMI can be removed after you reach 20% equity.

To be eligible, you must:

  • Have a 620 credit score
  • Have a 3% minimum down payment
  • Have a maximum 50% DTI ratio

Freddie Mac HomeOne and Home Possible

Freddie Mac’s HomeOne mortgage is reserved for first-time homebuyers and doesn’t include any income restrictions. The Home Possible® loan is an option for first-time and repeat buyers with a low to moderate income.

Your income must not exceed 80% of the AMI for a Home Possible® loan. You may qualify without a credit score, but your minimum down payment rises from 3% to 5%. Cancellable PMI is required for borrowers who put down less than 20%.

There’s a homebuyer education requirement for both HomeOne and Home Possible® programs when all borrowers on the loan are first-timers.

To be eligible, you must:

  • Have a 3% minimum down payment
  • Have a minimum 660 credit score
  • Have a maximum 50% DTI ratio

FHA loans

The Federal Housing Administration’s (FHA) low down payment home loans require just a 3.5% contribution and a 580 credit score. You can also qualify for an FHA loan with a credit score of 500 to 579 if you have at least a 10% down payment. Other FHA loans, such as construction-to-permanent loans and 203(k) loans, have the same credit score and down payment requirements.

FHA loans require upfront and annual mortgage insurance premiums (MIP). The upfront premium is 1.75% of the loan amount; the annual premium ranges from 0.45% to 1.05%, is divided by 12 and paid in monthly installments as an addition to your mortgage payment. Borrowers who put down at least 10% only pay mortgage insurance for 11 years; putting down less means you’ll pay MIP for the life of your loan.

To be eligible, you must:

  • Have a 580 credit score and 3.5% down payment
  • Have a 500 to 579 credit score and 10% down payment
  • Borrow within your county’s FHA loan limits
  • Have a maximum 43% DTI ratio

Good Neighbor Next Door

The Good Neighbor Next Door program from the U.S. Department of Housing and Urban Development (HUD) allows homebuyers in certain public service professions to buy a home at a 50% discount. If you qualify for and use an FHA loan to buy a home, the down payment is only $100, instead of the minimum 3.5% that’s usually required.

Eligible borrowers must buy a home located in a HUD revitalization area and commit to live in the home for at least three years. They must also sign a silent second mortgage for the discounted amount, though no payments are required if all program requirements are met.

To be eligible, you must:

  • Be a full-time pre-K through 12th grade educator, emergency medical technician, firefighter or law enforcement officer
  • Buy a home in a HUD revitalization area
  • Qualify for a conventional, FHA or VA loan
  • Live in the home for at least three years

Pros and cons of no or low down payment

Pros

Cons

  • Buy a home sooner. It can take years to save up for a larger down payment. By contributing 0% down or the lowest possible amount, you can reach your homeownership goal in less time.

  • Avoid depleting your savings. If you limit how much money you contribute to your home purchase, you can leave some of your emergency savings intact. Lenders want to know that you can weather financial hiccups, such as a job loss or income reduction.

  • Start out with less equity. The less money you put down, the less home equity you’ll have initially. This means your ownership stake in your home is much smaller, which may lead to pocketing less money if you need to sell in a few years.

  • Take out a larger mortgage. A no- or low-down-payment mortgage means you’ll be close to financing 100% of your home’s purchase price. A larger mortgage means a higher monthly payment amount.

  • Pay more in interest over time. The more money you borrow, the higher your interest rate typically will be. This also means you’ll pay more in interest over the life of your loan.

FAQs about mortgage down payments

Yes, there will be closing costs to pay on your home loan. Mortgage closing costs can range from 2% to 6% of your loan amount. You can pay these costs out of pocket at the closing table, or ask your lender about a no-closing-cost mortgage. With this type of loan, your lender will either increase your mortgage rate or add the closing costs to your loan amount, instead of having you pay those costs upfront.

It depends on the type of mortgage. Conventional loans require private mortgage insurance when you put down less than 20%, and it can be canceled after you’ve built at least 20% equity in your home. All FHA loans require mortgage insurance premiums, but if you put down 10% or more, you can get rid of MIP after 11 years.

Reach out to your loan officer and real estate agent for help identifying any down payment assistance programs you might qualify for. You should also check with your state’s housing finance agency.

Many loan programs let you use monetary gifts from family members, friends and others to help cover your down payment, but there must be a specific paper trail for the gift. The donor will need to submit a gift letter to show that you won’t have to repay the money being gifted to you. Consult your lender for specific guidelines.

Yes, your down payment amount can affect your mortgage rate. The less money you put down, the riskier you can appear to lenders, and they can account for this risk by raising your mortgage rate.

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Fact Checked By: Deborah Kearns

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By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.

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Mortgage

5 Home Loans for People With Bad Credit

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

You don’t need a perfect credit score to get a mortgage — there are home loans for people with bad credit. But before getting this type of mortgage, find out how a lower credit score affects your overall borrowing costs.

Buying a home with bad credit

It’s possible to buy a home with bad credit — you could have a credit score as low as 500 and still qualify for a mortgage. The lower your credit score, though, the fewer lending options you’ll have and the higher your mortgage rate will be.

FICO scores, the credit scores used by most lenders, typically range from 300 to 850. Having a lower credit score translates to higher risk for a lender, and vice versa. Any score 669 or lower is considered “fair” or “poor.” Here’s a breakdown:

  • Exceptional: 800 and higher 
  • Very Good: 740-799
  • Good: 670-739
  • Fair: 580-669
  • Poor: 580 and lower 

Lenders like to see high credit scores because it exhibits an ability to manage debt, make on-time payments and use credit responsibly. Your creditworthiness will come into question if you plan on buying a home with bad credit, but it doesn’t have to hold you back from homeownership.

5 home loans for bad credit

Consider one of the following home loans for bad credit.

Fannie Mae HomeReady

Fannie Mae’s HomeReady mortgage program is an option for both first-time homebuyers and repeat buyers with limited access to down payment funds and a fair credit score. This conventional home loan has cancellable mortgage insurance for those who put down less than 20%, and gives borrowers the option to use boarder or rental income to help them qualify. If all borrowers on a loan are first-timers, at least one borrower is required to complete a homeownership education course.

Eligibility requirements include:

  • A minimum 620 credit score
  • A minimum 3% down payment
  • A low- to moderate income

FHA Loans

Mortgages backed by the Federal Housing Administration (FHA) could be considered bad credit home loans because they make it easier for low-credit-score homebuyers to get a mortgage. FHA loans have a low down payment requirement, but you’ll pay mortgage insurance premiums (both upfront and annual) for the life of your loan. If you put down at least 10%, you can get rid of mortgage insurance after 11 years.

Eligibility requirements include:

  • A minimum 10% down payment for a 500-579 credit score
  • A minimum 3.5% down for a 580+ credit score
  • Borrowing within your county’s FHA loan limits

USDA loans

The U.S. Department of Agriculture (USDA) insures mortgages funded by approved lenders through the USDA home loan program. There’s no minimum required credit score, but a 640 score could help you get approved automatically if you meet employment and income requirements.

Eligibility requirements include:

  • No minimum required down payment
  • Meeting local income limits
  • Buying a home in a designated rural area

VA Loans

The Department of Veterans Affairs (VA) also offers bad credit home loans through approved lenders for active-duty service members, veterans and eligible spouses. The VA doesn’t have a specific credit score requirement, but lenders may require a minimum 620 score. No down payment is required. Additionally, most borrowers will have to pay an upfront funding fee to offset the cost of VA loans to taxpayers.

Eligibility requirements include:

Non-qualified mortgage loans

The loans discussed above are all qualified mortgages, meaning they meet certain requirements that establish a borrower’s ability to repay a loan. There are also non-qualified mortgage (non-QM) loans, which have more wiggle room for high-risk borrowers, such as accepting credit scores below 500.

Eligibility requirements include:

  • Demonstrating your ability to repay the loan
  • A minimum down payment up to 20%
  • A maximum debt-to-income ratio of up to 55%

How to get a home loan with bad credit

Use the following list of tips as a resource to help you get a bad credit home loan.

  • Avoid applying for new credit. A new auto loan, credit card or personal loan application means you’ll have new inquiries on your credit reports, which can drop your credit score.
  • Dispute any credit report errors. Finding and disputing inaccurate information on your credit reports could improve your credit score and help lenders see you as a less risky borrower.
  • Pay your bills on time. Your payment history makes up the biggest chunk of your credit score at 35%, according to FICO. Making on-time payments can help boost your score and demonstrate your creditworthiness as a borrower.
  • Lower your outstanding debt load. Pay down your credit card and loan balances. Lenders don’t want to see that your income is stretched too thin to afford a mortgage. Keep your credit usage below 30% of your maximum credit limit across each of your accounts.
  • Don’t close any accounts. Closing old accounts, especially credit cards, shortens your overall credit history and can negatively impact your credit score.
  • Have your rent payments reported to the credit bureaus. As long as you’ve been maintaining an on-time rental payment history, having your rent payments reported to the bureaus may boost your score.
  • Make a larger down payment. A larger down payment can compensate for a lower credit score. Don’t completely drain your cash reserves, though. Keep three to six months’ worth of living expenses in a savings account for emergencies.
  • Pay for mortgage points. If you have the extra cash, consider buying mortgage points to lower your interest rate and overall loan costs. One point is equal 1% of your loan amount and can lower your rate by up to 0.25%.

Should you get a bad credit home loan?

Home loans for bad credit come with more risk for lenders, so you can expect to pay more as a borrower. Crunch the numbers with a mortgage calculator to help you determine whether to move forward with a bad credit mortgage or wait until your credit profile improves.

Here’s an example of how your credit score can affect your costs on a 30-year, fixed-rate mortgage:

 620 credit score760 credit score
Mortgage rate4.84%3.25%
Loan amount$200,000$200,000
Monthly payment
(Principal and interest)
$1,054.17$870.41
Total interest cost$179,501.82$113,348.55

As you can see, improving your score from “fair” to “very good” could amount to a mortgage payment that is nearly $184 less each month, saving you more than $2,200 each year and more than $66,000 in interest over the term of your mortgage.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.