They are similar to a private investor … the difference is the private investor usually uses a mortgage broker to put the deal together so they do not have to deal with the public. That mortgage broker then becomes a hard money lender … they might have an entitlement private investor group to pool money from, potential lending hundreds of millions of dollars. Or they may be representing one or two private investors with very limited funds available.
Hard money lenders serve a very specific reasons and that is why most people have not heard of them unless then are real estate investors. When you get private money like hard money they do not usually have the requirements that the banks have. They usually look only at the property being purchased and base their lending off of the property exclusively.
So let's say for example you find an 100 unit apartment building that is being sold at 50% of market value. You recognize that there are repairs that need to be made and the property is currently sitting empty. The hard money lender will come in and give you up to 65% – 70% of ARV (after repair value) some of which will go to closing costs, repair costs and holding costs (you could negotiate not make payments for 6-12 months) during repairs).
Another benefit is that you can close quickly. Sometimes depending on the size of the deal you can close in 24 hours on smaller properties and 10-14 days are larger commercial deals. So going back to our example, not only are they giving you 100% financing without payments for 6-12 months (they typically will not let you go past that), they can close quickly so you get in and out of the deal faster .
Looking at it from the perspective of the lender. They are very on turning the money over quickly to make their profit and that is why they will charge 5-10 points up front just to do the deal. Then they have a balloon payment due in 6-12 months and they charge up to 18% annual interest to hold the money. If they can turn that money over 2-3 times during the year they can make profits of 30-45%. Not bad for taking on properties that have significant equity in them. They do assume that you will default on every loan but are not too worried because of the equity in the property.
Hard money is a great option for fix and sell deals or fix and refi deals so that you do not have to take much cash out of you pocket. Make sure that you have a hard money lender as part of your team so that if a deal like this comes across you desk you know where to take it.