The terms “hard money lender” or “private money lender” are thrown around quite often in the real estate investing world, but you’d be surprised how often these terms are misunderstood and misused. These lenders are often hailed as last minute saviors, or disparaged as usurers, but the fact is that they are merely one of many lending options that may or may not be appropriate for a given loan.

To begin with, we’ll define hard money (or private money) as money borrowed from an individual or extremely small firm, who lend their own capital. Borrowing money from a hard money lender is like borrowing money from your uncle instead of borrowing money from a bank, and as such these loans are entirely subject to that individual’s case by case decisions about a loan, not based on rate sheets or objective loan programs.

This has several implications for hard money loans. First of all, they are extremely expensive; rates typically vary between 12-20% and points typically range from 2-8%. Second, they are extremely fast, due to the small-scale nature of these lending operations. Third, they are conservative with loan-to-value (LTV) ratios, only lending a small fraction of a property’s value. Finally, they are usually short-term, as hard money lenders prefer a high turnover rate so as to continue lending the same limited pool of capital.

So what kind of borrower or scenario would benefit from such a loan?

Generally speaking, hard money loans are only advised for seasoned real estate investors, who know precisely what they’re doing by borrowing hard money. Homeowners, by contrast, are usually not well advised to borrow such expensive, short term loans, as homeowners tend to misunderstand the complexities of such a loan and tend to own their real estate for longer periods.

When is it appropriate to borrow hard money for real estate investing?

There are several advantages to hard money loans, which may justify their use. As mentioned above, hard money lenders are fast and responsive, and can often settle in just a few days, unlike lethargic banks and traditional mortgage lenders. Additionally, they will sometimes lend to borrowers with poor credit or un-documentable income, because they are lending at such a low LTV ratio.

This makes them a good choice for real estate investors who need to close a loan immediately in order to take advantage of a bargain property, or for real estate investors who may not be able to easily prove income. However, they are typically only useful for short term real estate investing, due to balloon terms and their high cost.

Because of their speed and flexibility, hard money loans tend to be a viable option for real estate investors looking for short term renovation or construction financing.

Serious real estate investors need to establish relationships with many different types of lenders, from national banks to neighborhood banks to hard money lenders, depending on the deal at hand. Some deals will require inexpensive, long term financing while other deals will require fast, flexible financing so be sure to establish relationships with all types of lenders, for all the occasions in the real estate investing world.