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Can You Use a Hard Money Loan to Purchase a Short Sale?

by K.C. Hernandez

The short sale process can present many hurdles, making it difficult to finance the purchase of a home. A buyer with serious credit problems faces a particularly daunting challenge when seeking short sale financing. In a short sale, the homeowner requests that his lender allow a sale for less than the mortgage debt owed. Investors and regular buyers use hard money loans to purchase short sale properties to avoid missing out on profitable deals

Hard Money Doesn't Come Cheap

Hard money lenders require a down payment of 30 percent to 50 percent. The down payment on a home intended for repair may require a heftier down payment based on an "after repaired value," or ARV, which is higher than the short sale home's purchase price. For example, an investor buys a short sale for $100,000, and plans to renovate and re-sell, or "flip," the house, for $150,000. The hard money lender requires a 30 percent down payment based on $150,000, rather than $100,000.

Terms in Lender's Best Interests

Hard money lenders charge a high interest rate, usually between 10 percent and 18 percent. They also charge loan points. A point equals one percent of the loan amount, and a hard money loan can cost 2 to 4 points. You have a short amount of time to repay a hard money loan -- usually between three and 12 months -- although some loans may allow up to five years, according to RealtyStore.com. Hard money lenders can defer interest until the end of the repayment term, which you pay off with the loan balance upon selling, refinancing, or otherwise obtaining the funds to repay the loan.

A Short-Sale Friendly Option

A buyer can purchase a short sale at a bargain price due to the extensive approval process associated with this type of distress sale, which takes several months to more than one year to complete. The lower demand for this type of sale may help keep a short sale home's price down. Also, short sale homes may have defects and repairs that a financially distressed home seller is unwilling or unable to cover. Poor property conditions also can drive the price of a short sale down and make traditional financing impossible for a buyer to obtain. As such, cash buyers or hard-money buyers can vie for short sale homes better than traditionally financed buyers.

When It Makes Most Sense

Using a hard money loan to buy a short sale makes sense when it is more convenient than a traditional home loan or buying with cash. Buyers might prefer to hold onto their cash to invest in other properties or improve the short sale home after purchase. A hard money loan may also bridge the gap between payouts for a buyer whose money is tied up elsewhere -- such as in a previous home he plans to sell -- but who doesn't want to miss out on a short sale opportunity.

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