Successful investors started in real estate by using hard money loans. A lot of people consider this a “last resort” financing because of the high interest rate used by lenders. Before you think that private money lenders are nothing but selfish Mafia-like individuals who prey on the desperate, be sure to hear their side first. So why is the interest rate for hard money loans high?

First of all, it will help to know that the interest rates in this kind of creative financing can reach up to 20%. An 18% rate, composed of a 13% interest and 5% origination fee, is common across the country. Some lenders use the points system, wherein they are repaid using points. One point is equivalent to one percentage point of the borrowed money. For example, if you agreed to pay three points for a $100,000 loan, you will have to repay $103,000 in total.

Rates and points vary depending on location and lender but they are usually twice as high compared to those used by banks and other conventional lenders.

This high interest rate is a defense mechanism of private money lenders. They use this to discourage borrowers who are uncertain if they will be able to repay the loan they want to secure. It is but natural for these lenders to do this as they seek to protect their money. Remember, hard money loans come from the personal savings of the lenders. If you were the lender, you will also seek to protect your money.

Second, they use this to ensure the survival of their business. Compared to traditional lenders, hard money lenders are more exposed to risks of sustaining losses because they release money even to those who do not have good credit scores. They hardly scrutinize the current income and credit report of a borrower. Instead, they just take a look at the deal the borrower wants to seal using their money. If the lender thinks that deal is profitable, then they will approve the loan. This “looseness” in assessing borrowers makes them more exposed to possible defaults.

Despite the higher interest rates, a lot of real estate investors still use this kind of financing. It’s because they are able to close deals using other people’s money. The return in real estate investing is also high enough to offset the interest rate of hard money loans so investors actually don’t mind paying it.