Hard money loans can be an excellent option for those who need quick access to capital for their projects. For those unfamiliar with hard money loans, they are short-term loans secured by real estate property and typically used for renovation projects or flipping houses. These loans are attractive because they often offer quicker approval times than traditional financing options and have more flexible requirements.
Read on to learn more about how hard money loans are calculated so that you can make an informed decision.
Calculation of Hard Money Loans
Purpose of Hard Money Loan
Hard money loans are usually short-term loans, lasting up to five years. They are typically used for projects that require quick funding, such as flipping a house or making repairs. Hard money loans are secured by the property rather than the borrower’s creditworthiness. This makes them less risky for lenders, who can foreclose on the property if the borrower defaults. As a result, interest rates on hard money loans are typically higher than on traditional bank loans.
When calculating a hard money loan, it’s essential to keep all of the following factors in mind.
- The amount you borrow
- The term of the loan
- The interest rate
These impact how much you will end up paying back, so it’s best to have a clear idea about them before making a decision.
Calculate the Loan Amount
Before calculating your monthly repayments, you need to know the loan amount. This is the total amount of money you’ll borrow from the lender. Understanding how much this amount is can help you plan ahead.
Calculate the Interest Rate
To determine the total interest payment, you need to know the monthly loan repayment amount and the time the loan is held. The formula is the monthly repayment amount multiplied by the number of months the loan is held. For example, if the monthly repayment amount is $1500 and the loan is retained for 12 months, the total interest payment would be $18,000.
Calculate the Loan Term
The loan term is the time you’ll be paying back the loan. Generally, hard money loans have short loan terms, ranging from one to five years. Calculating the term can help you determine the repayments and plan your finances accordingly.
Calculate the Loan Repayment Schedule
The loan repayment schedule is the frequency you’ll be making payments. Most hard money lenders will require you to make monthly payments, although some may allow you to make bi-weekly or quarterly payments.
Example
To illustrate how a hard money loan stacks up against a traditional mortgage, let’s look at a repayment example. In this example, we assume a loan amount of $200,000, a loan term of 360 months for a traditional mortgage, a loan amount of $200,000, and a loan term of 24 months for a hard money loan. The interest rates for the two types of loans are 5% for the mortgage and 10% for the hard money loan.
The monthly repayment for the traditional mortgage comes in at $1,073.00, and the total interest paid is $186,815.32. On the other hand, the monthly repayment for the hard money loan is $1,666.67, and the real interest paid is $20,000.04. It’s easy to see that the hard money loan requires a larger monthly payment and a much higher interest rate. However, the benefit of a hard money loan is that it only requires a 12-month holding time, making it the ideal financing option for investors looking to flip a property.
LTV Ratio
The LTV is a ratio expressed as a percentage used to measure the amount of a loan relative to the value of the purchased property. A higher LTV ratio generally means higher risk for the lender. For hard money loans, lenders typically require a lower LTV ratio than other forms of financing, such as conventional mortgages. This is because hard money loans are typically considered higher-risk investments. The LTV ratio is calculated by dividing the loan amount by the property’s appraised value. Generally, hard money lenders require a lower LTV ratio than traditional lenders, typically ranging from 50-75%.
When a borrower takes out a challenging loan, the lender typically requires a down payment of 10-25% of the loan amount. To calculate the monthly payments for a challenging loan, the borrower will need to know the loan amount, the interest rate, and the repayment period. The borrower can then use a loan calculator or an online calculator to determine the monthly payment.
Benefits of Hard Money Loans
Now that we’ve discussed how hard money loans are calculated, here are some benefits of these short-term loans,
- Quicker approval process: The lender will consider the property, the amount of downpayment, the exit strategy for the property, and the lender’s capacity to make monthly payments. If all these are reasonable, it can just take a few days to be approved.
- Less rigorous process: Since hard money lenders focus more on the value of the property used as collateral than the borrower’s finances, the process is less rigorous than traditional loans.
- Less attention to borrower’s credit score: Hard money lenders don’t have to follow the same regulations as traditional lenders so they pay less attention to the borrower’s credit score and debt-to-income ratio.
- Convenient: Hard money lenders finance projects that most traditional lenders hesitate to fund; this makes them a convenient choice for most borrowers.
If you want to learn more about how hard money loans are calculated, don’t hesitate to reach out to South Star Wealth Management! Our team of experienced professionals will comprehensively explain the process and help you make the best decision for your financial future. Contact us today to get started!