Unless you have deep pockets, financing a development project or purchasing a property to renovate and resell means finding the right type of loan. You basically have two options: one is to seek a traditional loan from a bank or similar institution. The other is to do business with a hard money lender. Here are some things you should know about the latter option and what the term hard means as it relates to financing.
Is Hard Money Better or Worse Than Soft Money?
There’s no difference in the money you receive from a hard money loan. In terms of usage, it’s no better or worse than the money provided by taking out a mortgage. The hard part in a hard money loan is all about what it takes to receive the financing and the terms you must abide by in order to successfully pay off the loan. While this type of arrangement does come with some benefits, there are also aspects that are less favorable than the terms associated with more traditional loans. Knowing the difference in those terms helps you decide if a hard money loan is right for you.
The Type of Lender Who Offers These Loans
Hard money loans are usually extended by entities other than traditional lending institutions. Your local bank or credit union won’t have them. In order to obtain such a loan, you will need to work with a private investor, an investor group, or a finance company that specializes in these types of loans. Keep in mind that the process used to evaluate your application will be different from the process utilized by your bank when you purchased your private home.
Qualifying for a Hard Money
Lenders who offer hard money loans evaluate applications differently from lenders of soft money. The methods they employ are less complicated and make it easier to make a decision in a shorter period of time. While it might take a traditional lender several days or weeks to approve or reject your loan application, a hard money lender usually makes a decision in a couple of business days, or at least less than a single week.
One difference has to do with what each type of lender considers to be more important. Hard money lenders are less concerned about credit scores and more interested in the positive or negative comments found on your credit reports. They want to know your recent history demonstrates that you take paying your bills on time seriously.
These lenders will also consider the value of the asset you will pledge as collateral. If you were to default on the loan, would the sale of that asset bring enough to cover the remaining balance plus the associated fees and penalties? If the answer is yes, you have a good chance of being approved.
Remember that unlike going to the bank for a mortgage or a line of credit, you are not dealing with an institution with a detailed process for evaluating applications. In many cases, the hard money lender is an individual or a group of individuals. They can move faster in terms of checking your information, asking any questions that come to mind, and making a decision.
The Interest Rate
One of the elements that makes a loan hard is the interest rate that applies. So-called soft money loans typically come with interest rates that are at or below the current prime interest rate. Lenders who offer hard money loans streamline the application process and don’t look at some of the factors more traditional lenders consider important. Some would say that means hard money lenders take on a greater level of risk than more traditional ones.
To offset the risk, those lenders will charge a higher interest rate. Keep in mind that the actual interest you pay may be represented by two figures: the origination and the applied interest. Adding them together will provide a better idea of how much interest you are actually paying.
The Loan Duration
If you are looking for long-term financing, a hard money loan is not for you. Most loans of this kind come with a term of no more than a couple of years. You might be able to find a hard money lender who is willing to approve another year or two, but that’s extremely rare.
While this loan is great for short-term financing, such as buying a property to renovate and resell in 12 months or less, it’s not a substitute for a standard mortgage. If you think that hard money will do as a bridge between the purchase and a time when you can qualify for more traditional financing, this approach can work well.
Don’t let the reference to hard money intimidate you. Like any type of lending arrangement, there are responsibilities the debtor takes on in exchange for receiving the financing. Make sure you know what those terms happen to be, commit to honoring all of them, and you will end up with a lender who will be happy to continue doing business with you in the future.