Both hard money and soft money loans exist. What’s the difference? Both can be profitable. It’s critical to understand the differences between each of them.
This blog post is here to help you understand differences and similarities between hard money loans and soft money loans. Both types of loans can be profitable depending on your usage. It’s important to understand the fundamental distinctions of each of the types of loans.
What’s a soft money loan
Soft money loans are traditional loan with a below-market interest rate. This is a type of loan which has a longer repayment period. Car loans are an example of soft money loans. Some car loans, which are an example of soft loans, have 0% APR(for a period of time), and repayment periods which can range from 2-6 years. Soft money loans are usually provided by certified lending institutions.
What’s a hard money loan
Hard money loans are short term bridge loans which are backed by an asset – such as a property. The credit worthiness of the borrower isn’t as important in this case. These types of loans are funded by private investors, and have rigid rules and lending criteria. Hard money loans are designed to be shorter, and are usually repaid in 3-12 months.
Similarities between Hard and Soft money loans
Both kinds of loans have repayment terms, and eligibility criteria. Both have rules that protect the investment if the deal goes bad.
Differences between hard and soft money loans
One of the biggest differences is your credit score. Soft money loans require some asset as collateral, in addition to your credit score being important. To qualify, you must have a credit score above 580. In addition, the higher the credit score – the lower your interest rate and longer your repayment period.
With hard money loans, your credit score isn’t important. Hard money lenders, like Zogby, focus on the quality of the asset(property), rather than your credit quality. You can get funding for a hard money loan very fast, assuming you have the necessary documents to prove the asset is worth it. Here are the pros and cons of each investment loan.
Pros and Cons of Soft Money Loans
- soft money loans have lower interest rates depending on your credit score
- soft money loans can fund up to 90-95% of the property’s LTV
- when you take a soft money loan, it becomes part of your credit history, and can help rebuild your credit
- soft money loans have a flexible payment schedule
- you can’t get approved with bad credit
- you have to give up assets as collateral for the loan
- you have to prove you have 3-6 months worth of loan payments in reserve, in addition to having good credit
- soft money loans have long closing times
Pro’s and Cons of Hard Money Loans
- easier to get since your credit score/history is ignored
- easier to achieve your goals with a hard money loan, even if you have poor / bad credit
- hard money loans don’t require a down payment, nor do they require proof of loan payments
- you can close in 3-5 days
- the loans are short term, and interest rates are higher
Hard money loans are the best way to go in real estate. They allow you to move fast and quick, and are suitable for flipping properties, constructing new properties, or as bridge loans for transactions. These types of projects typically require you to borrow cash quickly for a very short time. Once you understand the critical differences between hard and soft money loans, you will realize that hard money loans are better for real estate investors.
What Happens if a Borrower Doesn’t Pay Back The Hard Money Loan
Hard money lending can be a fantastic short-term solution for real estate investors that need cash quickly, easily, and with a variety of terms and payment schedules. While many lenders are considerate of the borrower’s specific situations, they also have a responsibility to protect their money at all costs, which means acting appropriately when a borrower defaults on a debt.
There are several situations that can cause a borrower to default and the terms can change wildly from loan to loan. When taking out a hard money loan, it’s best to understand the terms and conditions specific to that individual agreement.
The following is a list of all the reasons a borrower could default on a hard money loan:
Missed Payment – Due to the short-term nature of a hard money loan, a simple missed payment could be all that’s required for the lender to call the loan as due.
Missed Balloon Payment – Nearly all hard money loans come with a balloon payment that is much larger than the individual monthly payments and is due at the end of the agreement. Generally, the borrower is able to make this payment due to the sale of the investment property, but if they can’t for whatever reason, the lender may foreclose on the property.
Changing Conditions – Depending on the terms that the loan was originated with, different financial conditions on the part of the borrower can be enough to convince the lender that they need to call the loan due immediately, rather than later. This process isn’t as arbitrary as it sounds, but if the loan is called legally and you’re unable to pay, it can be cause for default.
Deterioration – If the condition of the investment property deteriorates to a level below a threshold deemed acceptable, the lender may foreclose on the property or ask for an advance of funds.
Illegal Transfer – Some contracts stipulate that the borrower must keep the property in his name. Unauthorized transfer of the property could result in a default of the loan as well, along with certain penalties.
What Happens if I Default On My Loan?
Due to the truncated nature of hard money loans, the average lender may choose to call the loan quicker than average traditional lenders, but there are still a few steps before total foreclosure.
For starters, a default or missed payment may cause the lender to increase the interest rate on the loan substantially; in some cases, even up to double. Hard money loans have interest rates that are much higher than average loans – they usually begin at 12% and go up from there – so a default can increase it to 25-30%, or even higher. A payment of $1500 can go up to $3000 or even higher, making it nearly impossible for the borrower to make the bill current. If it stays in default, the lender may choose to move on to more drastic measures.
A foreclosure occurs when the bill is called due and the borrower is unable to pay. In this event, the borrower will most likely decide to sell the collateral and keep all of the current payments as a penalty for loan default. If the borrower is close to the end of the life of the loan, this could mean several thousand dollars that are simply lost. In most cases, hard money lenders do not report a default to credit bureaus due to the cost, but they may choose to do that as well.
Another option for the borrower is called “deed in lieu of foreclosure.” If the lender accepts, the borrower may give the property back to the lender instead of having a foreclosure appear on their record. Too many foreclosures can affect the borrower’s ability to secure a traditional loan in the future, although borrowing from another hard money lender may be an option. If the borrower pursues a deed in lieu of foreclosure, they must gain a release from the lender, or they could be on the hook for the property and the loan as well.
Dealing with a hard money lender can be a great experience, but as with anything financially-related, it also comes with some dangers as well. The end goal of any money lender is not to take over your property. Their goal is to make a return on their investment. If you don’t make timely payments, though, you could see your property taken over by the investor.