Hard money loans can be an attractive option for investors looking to finance their multifamily real estate projects. These loans are typically used for short-term investments and are based on the value of the property rather than the borrower's credit score.

However, as with any form of financing, it's important to understand the advantages and disadvantages of hard money loans, as well as the key factors to consider when using them for your multifamily real estate investments.

We'll review three key tips for using a hard money loan for a multifamily purchase, followed by an examination of the pros and cons of using this type of financing. Not sure if a hard money loan is right for you? We'll walk you through your options — fill in the form below.

Three Tips for Using Hard Money Loans

1. Understand When Your Property Will Turn a Profit

One of the biggest advantages of hard money loans is that they can provide quick financing for real estate investments. However, this also means that the loan terms are much shorter than traditional bank or agency loans. It's important to have a clear understanding of when your property will turn a profit — if your property is still in the red when it's time to refinance, this could be trouble.

Let's illustrate with an example.

John is looking to acquire a property. He knows the community in is in a desirable location, and he's confident that it will attract high-paying tenants. He also knows that the area is growing, so there is higher demand for luxury rental properties. However, he wants to be certain that his investment will be profitable before taking a two-year, $4 million hard money loan.

To do this, John performs a thorough analysis of the property's effective gross income and expenses. He takes into consideration the estimated rent he can charge for each unit, the property's operating expenses, and any potential capital expenditures. Based on his analysis, John determines that the property will turn a profit after 12 to 18 months.

With this information, John can confidently proceed with the hard money loan, knowing he should be able to easily refinance the loan before the balloon payment is due.

2. Clearly Understand the Loan Terms

Hard money loans typically have higher interest rates and fees compared to traditional mortgages. What's more, the loan terms can vary widely depending on the lender, as it's not a standardized loan product. To avoid any surprises down the line, it's important to clearly understand the loan terms. Look at the interest rate and repayment period, and also take note if the loan is interest-only — many are.

Also keep an eye out for any prepayment penalties. Typically, hard money and other bridge loans do not have penalties for paying off the loan early, but it pays to be prepared.

3. Ask Many Questions

Don't hesitate to ask questions and resolve any doubts you may have about the loan terms and conditions. Even if you're working with a reputable lender, don't completely rely on them having your best interests at heart.

And your lender may even change. Small hard money lenders often don't have the resources to service their loans in-house. This could indicate that they'll either sell the loan or hire a third-party servicer. Since you would no longer be working with the original lender, this could potentially create some challenges down the road.

Because there are so many varieties of hard money loans, we would strongly encourage you to seek expert advice from a broker or loan advisor who understands your property, the market, and the current state of financing. We can help with that.

Hard Money Loans: Advantages and Disadvantages

There are great reasons to get hard money financing, but they are absolutely not for every investor or scenario.

Advantages of Hard Money Loans

They're Quick

Few loan products can compete with a hard money loan's speed of execution. When a fast close is necessary, these may be the only option in town. Yes, you will pay more for the speed, but it's a small price to pay if your deal hinges on a fast close.

They're Flexible

Flexible underwriting can be a huge advantage, particularly if your personal credit score isn't anything to write home about. Hard money loans are based on the value and income of the property itself, not your credit history, so this can make it significantly easier to secure a competitive loan.

They're Short Term

If your investment strategy is for a short-term hold, a hard money loan may be what you need. This type of financing can be very beneficial for fix-and-flip investments.

Even for longer-term investments, hard money loans' short terms can be a key advantage. We'll use an example: Shawna plans to buy a multifamily property that she believes has great potential. The property is in need of some renovations, but she's confident that she can make it profitable with the right upgrades. Shawna has two options for financing her purchase and renovation: a traditional long-term loan or a hard money loan.

Shawna decides to go with the hard money loan because she knows that she can use it to quickly acquire the property and make the necessary renovations. She also knows that if she goes for a long-term loan first, she'll be locked into an expensive loan for several years, thanks to prepayment penalties.

With the hard money loan, Shawna can renovate the property, reposition it as a high-end multifamily asset, and then get better, long-term financing once the property is stabilized.

Disadvantages of Hard Money Loans

They're More Expensive

Undoubtedly, one of hard money loans' largest disadvantages is the extra cost you take on. Interest rates are much higher than standard, long-term financing, and significant fees are also not uncommon. Of course, these extra costs may be worth it, depending on your investment strategy and how you plan to utilize the loan.

They're Short Term

Yes — hard money loans' short-term nature can also be a disadvantage, depending on your situation. Let's look at the previous example with Shawna to illustrate. We know that Shawna wants to buy the community and reposition it.

That's all well and good…but what if the demand for luxury units in that area doesn't materialize? Shawna may be left holding the bag on a property that lenders and buyers will shy away from if the asset is plagued by vacancy issues. It would be very difficult for her to get a competitive refinance with the community in that state, and likely no buyers would be interested if they don't see a way to get it filled with residents.

Conclusion

To wrap things up, pay close attention to the three tips previous illustrated — they could make the difference between a successful experience and disaster. Beyond that, pay close attention to the upsides and downsides of these loans.

Simply put, hard money lending for real estate assets is not for everyone. If you have little experience flipping or stabilizing a property, you may want to think twice. For these reasons, it's critical to understand the key elements, ask questions, and engage professional support for any multifamily loan you take.