Hard money loans are typically private loans made by investment firms or individuals who lend money to borrowers based on the investment property being purchased. These types of loans are not focused on your credit score and are not available through conventional lenders or mortgage companies. Usually these loans cost (percentage-wise) more than an average mortgage and include higher origination fees.

Real estate developers and house flippers, among others, will use hard money to fund deals because this type of financing is not available through conventional banks. Hard money lenders will require you to collateralize your loan with real property. If you know you can buy a property and turn it around quickly for a large profit, and you can’t get a standard mortgage, the hard money loan might be a good option. Some investors use hard money to get into the property, do some quick fixes to raise the property value, and then get a new loan from a bank (based on the property’s new, improved value) to pay off the hard money lender. Hard money loans must be made to the investor’s limited liability company (LLC) or corporation for non-owner occupied purposes only.

Mainstream lenders typically deny loans to people with poor credit or unusual, quirky properties because they are required to adhere to strict industry guidelines such as those outlined by Fannie Mae. These specific rules and criteria are followed to reassure investors who purchase the loans in secondary markets.

The United States government supports this type of reselling of loans because it helps ensure that there will always be plenty of funds available to borrowers who need to buy homes with mortgage loans. Fannie Mae, for its part, bundles together mortgages and then issues “mortgage-backed securities” based on the total value of the loans in each bundle. These securities, which are traded much like stocks, can then be conveniently sold to investors around the world. To keep this kind of market working smoothly, the investors need to be confident that the loans they represent are solid and risk-free. As a result, the government sets strict lending guidelines.

Hard money lenders make up their own set of rules based on the level of risk that they are comfortable with and their own experience in the business. Because their portfolio of loans are much harder to sell to other investors, hard money lenders normally do not rely on selling loans to the secondary markets in the way that Fannie Mae does. Instead, they have to generate their own profits by charging higher interest rates and fees to the borrower.

Despite costing more and being less popular than conventional mortgages, hard money loans can be an invaluable tool to investors who need to close fast with flexible underwriting criteria.