Loans can be a financial solution to many. When you choose this solution, the very first thing you need to consider is the type of loan that can fulfill your needs. Generally, hard money loans are used by real estate professionals who need quick access to a large amount of money using real estate as collateral to retain the loan. Maximum LTV is 80%.
Hard money loans are somewhat similar to conventional loans. You apply for the loan and if your loan application is approved, the fund will be transferred to you. You will get a certain amount of time to repay the loan with interest. The overall structure of both types of loans are similar but they differ when you go deep down into details. They substantially differ in terms of the application process, terms and conditions of the loan, use of loan and the repayment schedule.
Comparison of the application process of hard money loan and traditional loan –
Hard money loans and conventional loans differ deeply in terms of the application process. Hard money loan is asset-based financing and equity-based lending that requires fewer documents in comparison to a conventional loan.
● Debt to Income (DTI) Ratio – Traditional banks review your entire financial situation including your income, the amount of debt you currently owe to other lenders, your credit history, and the size of your down payment to determine whether you are creditworthy or not. That is why they require a lot of documents. Their primary concern is the borrowers’ creditworthiness. They go through all the documents to make sure that their borrowers are creditworthy. The main thing that they would see is if you have enough income to repay the loan or not. Your creditworthiness is a determining factor in whether to approve the loan or not.
● Loan to Value (LTV) Ratio – Just like traditional banks are concerned with the Debt to Income(DTI) ratio, in the same way, hard money lenders are primarily concerned with the Loan to Value ratio (LTV). As hard money loans are asset-based financing, the value of collateral becomes a determining factor in approving the loan application. Your income and credit history does not matter here. The main thing that a hard money lender would see is if the current value of the collateral is enough to cover the loan. This is the reason why hard money lenders ask for property appraisals with loan applications.
Comparison of loan repayment terms – Conventional mortgage is a long term loan. You can have years, let’s say 15 to 30 years, to repay the loan. But hard money loans are short term loans and the repayment terms may vary from one lender to another depending upon the other factors. Generally, you will have 1 to 2 years to repay the hard money loan.
● Mortgages are for Owner-Occupied Residences – Traditional banks offer mortgages by assuming that the owner will occupy the property for residential purposes. Therefore the repayment schedule of traditional owner-occupied residential loans is generally for 15, 20 or 30 years. This keeps the payment low but a large amount of money over these years goes as interest.
● Hard Money Loans are for Investment Properties – Hard money loans are specially structured for the real estate sector. A typical repayment term for a hard money loan is 6 months to 2 years. The borrower has to pay back the principal with interest within this short period. Hard money loan repayment terms are intended to monetize the asset and repay the loan with interest so that you can move on to the next investment property. Hard money lenders do not offer loans for owner-occupied residences.
Comparison of funding sources – A traditional loan is offered by a conventional Bank. Their rules and regulations are applied equally to all and their guidelines must be followed. But when it comes to hard money loans, it is offered by any private individual or group of individuals. As it is not offered by any company, hard money lenders are flexible and you can negotiate on loan terms, repayment schedule, interest rates etc.
Loan closing time frame – This is one of the biggest factors in determining whether you need a hard money loan or a traditional loan. Traditional banks take months to approve loan applications and transfer the fund whereas hard money loans take a maximum of 2 to 3 days in approving the loan and fund transfer will take only 1 to 2 weeks depending upon the lender and lending factors. So if you need quick access to a large amount of money, you can go for a hard money loan. Especially in the real estate sector, where many buyers wish to purchase the same property, you can Finance the property by taking the service of a hard money loan.
Interest Rate – As a hard money loan is a short term loan, their interest rate is higher than a traditional mortgage. When a traditional bank lends you for 30 years, they would be collecting large amounts of small interest payments over these years. But hard money lenders do not have enough time to do this, so they put the interest rate higher. Hard money interest rates are also higher due to the fact that most of the financed properties are of higher risk. Borrowers with lower credit scores historically have higher default rates, therefore rates are higher on such programs in the event of foreclosure.
You can approach a hard money lender in case:
● You need a large amount of money urgently
● You could not qualify for a traditional loan
● You have low income or bad credit
● You want to bridge the gap of urgent money requirements and long term loan
● You want flexibility in loan terms
Though hard money loans give you quick access to large amounts of money, it is riskier too, not only for the lender but also for the borrower. You may lose the property that you have put as collateral in case of default or foreclosure. This is due to the higher interest rate and the fact that developing property sometimes comes with unforeseen roadblocks such as permitting, unexpected expenses that prevent a borrower from getting money and developing a property on time to make a profit.
Both hard money loans and traditional loans have their own specifications. As per your requirement, you can choose a hard money loan from a private lender or a conventional loan from a traditional bank. We have compared both types of loans and you can see which one is better for you. In the end, the right type of loan for you will depend upon your needs and priorities.