Whether you’re a first-time homebuyer or looking to invest, finding the perfect financing option is a top priority on everyone’s mind, with endless choices to explore!
To determine the ideal fit for your needs, familiarise yourself with how each loan type works and what are their point of difference from the others.
When you think of buying a property you have a variety of options available in front of you from crowdfunding to holding equity in the already existing home.
However, the most common ways that usually people at large consider are the traditional loan or mortgage. There is one more option that is gaining a lot of popularity in the financing market is to get a loan from hard money lenders.
So in this article, we have selected two financing options that people don’t know much about – Hard Money Loans and Mortgages. After going through this article, you will get enough insights to make the right decision for your next home buy.
What is Hard Money Loan?
A hard money loan is a type of short-term financing from a non-banking institution or a private lender against collateral, typically used by real estate investors or individuals who need quick access to funds.
Borrowers mostly refrain from hard money loan because it is security-backed and also incurs higher rate of interest as compared to conventional loans.
How Does a Hard Money Loan Work?
Hard money loan is considered by individual and real estate investors when they are left with no other financing option and need fund real quickly.
In such cases, the borrowers prefer taking up the fund against the security and once they are financially stable, they switch to the traditional way of financing.
It basically bridges the gap between quick purchase and resale of the property.
Real estate investors are tasked with finding a suitable property, acquiring it, conducting necessary repairs or renovations as needed, and increasing its market value for resale.
You might be wondering why traditional bankers not taking charge of lending hard money loans. It is because of their loan-to-value ratio (LTV ratio) which is higher to over 75%.
(LTV Ratio: Loan-to-Value (LTV) ratio is about expressing the percentage of the loan amount about the purchase price of the property. It helps lenders assess the risk associated with a loan.)
Thus, real estate investors choose private players to finance their projects, and property purchased acts as collateral for lenders. Since it is a short-term loan so lenders are not concerned with the investor’s income and credit history.
This method is suitable for new investors and the ones who have bad credit history and have higher chances of getting rejected by traditional banks.
If because of financial hardships or any other reason borrower is unable to pay the hard money loan, the lender may take legal action to recover their investment.
Since it is backed by the property as collateral, the lender has the right to foreclose on the property and sell it to recoup their money.
What is Mortgage?
A mortgage or mortgage loan (also known as a home loan or property loan) is a traditional way of financing which people usually use when they are planning to purchase a house.
In this method of financing, borrower approaches a financial institution like a bank to fund their need of buying a house.
And property purchased is used as collateral as a security in case of any failure in repayment of the loan or outstanding debt.
It is a long-term loan with repayment periods of 15, 20, or 30 years and the interest rate applied to the loan can vary depending on various factors such as creditworthiness, market rates, and the terms of the loan.
How Does a Mortgage Work?
Conventional loans or mortgages are typically used for real estate purchases allowing borrowers to loan the money for the entire purchase upfront and then pay it off along with interest over some time.
The mortgage taken on the property purchased is also called a lien against the property. It helps in a situation like if a borrower fails to make their mortgage payments then the lender has full right to foreclose the deal to get their funds back.
The process of a mortgage starts with the borrower applying for a loan, after that lender will assess the borrower’s financial stability to pay off the loan. Lenders check the financial stability of borrowers by looking into their credit history, proof of employment, bank statements, and other personal financial records. Once the lender is satisfied with the documents, he will specify the amount and give the borrower pre-approval of the loan.
After obtaining mortgage approval, the borrower proceeds to finalize the property purchase and once this process is completed, the loan can be issued and repayments begin.
The buyer remains the owner of the property until the loan is fully paid off unless they default on mortgage repayments.
Hard Money Loan Vs. Mortgage
If we compare the two i.e. hard money loans with mortgages then these are two financing options that people usually need help understanding, and what their purposes are?
When we talk about their purposes then hard money loan helps in expanding a business, whereas on the other hand, a mortgage helps home seekers to buy a house.
Hard money financing helps enhance business prospects by providing quick access to funds for property improvements, which ultimately helps in seizing opportunities and maximizing returns from the property.
Key differential pointers of hard money loans and mortgages:
Hard money loans are used for commercial purposes through which real estate investors can make money. On the other hand, mortgages are used to buy homes for residential purposes.
As their purposes are different so does their approval criteria. Hard money loans are more of an investment opportunity centered so their approval criteria are also focussed on LTV, ARV, and potential profit that the property will make.
And mortgages will be focussed on a borrower’s income, bank statements, credit score, and other personal financial indicators.
If we compare the two on a turnaround time basis then a hard money loan is quicker as there are fewer checks on borrowers’ personal financial history and the lender is more interested in the property purchased. Its underwriting takes less time which makes its approval and entire loan process faster and quicker.
Hard money loan terms vary depending on the loan type and lender. It is a short-term loan ranging from 6 to 24 months in length.
Say, for example, fix and flop loans may require only the interest payment during the loan period and the balloon payment of the remaining principal amount settled at the end.
Mortgages, on the other hand, are longer loans ranging from 5 to 30 years. In mortgages, there isn’t much room for flexibility apart from choosing fixed or adjustable rates and loan length.
Interest Rates and Fees
Hard money loans are for a shorter period and possess a higher risk for lenders, so they have a higher rate of interest which is somewhere between 6% to 12%.
Whereas a mortgage is for a longer period and possesses lower risk as compared to a hard money loan, the interest rates of this are lower i.e. 4% to 6%.
Rules & Regulations
Both are regulated by different rules and regulations one reason for this could be that hard money lenders are not part of the financial institution world which is more rigid and follow certain rules.
Hard money loans are funded by private lenders, who can be either individuals or companies, whereas mortgages receive funding from financial institutions, which then proceed to sell the loan to larger banks or other investors.
In summary, the primary difference between a mortgage loan and a hard money loan lies in their purpose, sources of funding, repayment terms, interest rates, and target borrowers. Mortgage loans are used for purchasing residential properties with longer repayment periods and lower interest rates, while hard money loans are short-term, high-interest loans typically utilized by real estate investors who need quick financing and don’t meet traditional lending criteria.