Sometimes, traditional bank financing isn't available for a real estate transaction. This can happen for any number of reasons, but the upshot is the same: If you want to purchase a home, you may have to be a bit creative. Your options might include an all-cash offer or a hard-money loan.
An all-cash deal is one that closes without a loan or a financing contingency. In an all-cash deal, the buyer either submits a cashier's check or provides funds through a wire transfer at or prior to closing. It doesn't mean, however, that the buyer shows up with a suitcase of neatly stacked $100 bills. While this is technically possible, in practice, it's not how deals get done.
Just because a deal is all-cash doesn't mean that the buyer is using his own money. Although he's not getting a traditional mortgage, he could still be borrowing funds to make the transaction happen. A buyer can tap into a line of credit, borrow from a retirement fund, or take loan on another property to facilitate an all-cash offer.
Hard-money lenders make mortgages that are tied to the value of the underlying asset, as opposed to the strength of the borrower. Such loans typically carry high rates and fees. Many hard-money loans involve low loan-to-value ratios, requiring the buyer to put more down than she would with a bank loan. However, a hard-money loan offers a relatively easy qualification process and can close very quickly. For many buyers, these benefits justify the cost of a hard-money loan.
Buyer vs. Seller
For a buyer, the source of money makes a big difference in the deal. A true all-cash offer means that she's tying up her money in the transaction. Borrowing money through nontraditional channels helps her conserve her money, even though she'll probably still be required to make monthly payments. For the seller, the concerns are different. The economics are the same regardless of how the borrower gets her money: If the seller doesn't get paid, the sale doesn't happen. However, with a true all-cash deal, the seller may be certain that the deal is being funded with money that the buyer already has. When the buyer uses a hard-money lender or other source of debt, there's always a risk that the loan won't go through.
Proof of Funds
To firm up an offer, a buyer using traditional bank financing may submit a proof-of-funds letter, a document from a bank certifying that the buyer has the funds necessary to close the transaction. Many hard-money lenders also offer proof-of-funds letters. These look like a bank letter, but are based on a borrower's theoretical ability to borrow rather than her actual cash on hand. Sellers may also request an actual bank statement.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.