Hard money lending, or private lending, is often misunderstood. Most mortgage and real estate professionals know little about the business. As a result, many fallacies, myths and misconceptions tend to dominate the collective wisdom.
The simple definition is that a hard money loan is an asset-based loan. Such loans are typically more expensive than those from conventional sources; i.e., "harder terms." Borrowers often turn to hard money lenders for deals that are "hard" for traditional lenders to finance. The asset is the collateral, or security, for the loan. The asset most commonly associated with the term hard money is real estate, although a loan against any 'hard' asset such as gold, precious stones or artwork could be a considered a hard money loan. A hard money lender looks primarily to the collateral as the ultimate source of repayment rather than to the capacity or willingness of the borrower to repay the loan.
All mortgage lenders in the 19th century focused entirely on the collateral. By necessity, they were hard money lenders. It was difficult, if not impossible, to verify a borrower's income, and credit reporting agencies didn't exist. Over the ensuing decades, many lenders, particularly banks and other institutions, began to focus more on the capacity of borrowers to service and repay their mortgage, as indicated by their income relative to their expenses, and their willingness to repay as reflected in their credit record. The collateral became less important, to the point of being almost ignored in the underwriting process. As a result, equity requirements (down payments) declined, and in many cases, disappeared entirely. In the go-go years before the real estate bubble burst, the competition for business caused some lenders to loan 100% or more of a property's value, relying totally on the borrower's capacity and willingness to repay the loan. We all now know the result of such practices. Banks and other lending institutions lost billions. On the other hand, hard money lenders who didn't get caught up in the hype and continued to lend conservatively based on a realistic value of the underlying asset, have come through this real estate meltdown relatively unscathed with their capital base intact.
A hard money loan is typically of short duration, 6 months to 2 years, with no pre-payment penalty. There is usually no amortization of principal during the loan term; the principal amount being due in one lump sum at maturity. The borrower makes monthly, interest-only payments as long as the loan is outstanding. A hard money loan should be thought of as a short-term answer to a financing need and not a long-term solution. As such, a hard money lender will be looking for the borrower to provide a clearly-defined exit strategy when applying for the loan.