Soft Money vs Hard Money in Real Estate Investing
Funding for your real estate investing is crucial to make money. In your investing business, soft money vs hard money are great ways to buy properties. But, do you know how and when to use either soft money vs hard money?
Soft money vs Hard money in real estate all comes down to a few things: Terms of the loan, Interest rate, and the fees. Hard money loans are asset based and will be a short term loan of 6-12 months, 12%-18% interest rate, and 2-3 points in fees. The Soft money loans are borrower based and will be long term loans of 20-30 months, 3%-5% interest rates, with 0-1 points in fees.
Just like how it isn’t easy to find the best real estate deal, finding the best loan is also a challenge.
It is important for real estate investors to know the difference between soft money vs hard money to choose the right funding for their investment.
Hard Money Definition
A hard money loan is loan that is based on the asset, not the borrower. The asset, typically real estate investment, is the asset and the loan is secured by the real property asset.
Usually, hard money lenders are not typical banks but rather private individuals or companies who lend their personal money.
Hard money definition is different than soft money definition.
What is Hard Money in Real Estate?
Hard money in real estate is the amount of money loaned from the lender to the borrower with high points (fees) and with a short-term duration.
The exact terms of this loan differ according to the particular contract between the lender and the borrower.
The hard money lenders are usually individuals or companies and not banks.
The borrower will receive the money and the lender will receive the loan’s monthly interest until it is fully paid back. The lender also charges the borrower a one-time upfront fee (points) for the loan to be processed.
A physical asset backs up a hard money loan and this is the property that will be purchased.
The more traditional loans depend on the credit score of the borrower.
How to Buy Rental Properties With Hard Money
It is possible to buy rental properties with Hard Money Loans.
If you purchase a rental property with a hard money loan and then refinance the property into a conventional 30 year loan, you have a rental with little to no money in the property.
If you learn how to invest in real estate with an investment property that makes you money every month and no money out of your pocket.
Soft Money Definition
A soft money loan is loan that is based on the borrowers credit score, debt to income ratio, and ability to repay the loan.
Institutional banks usually fund the loan and then sell the loan to the government agencies like Fannie May or Freddie Mac.
What is Soft Money in Real Estate?
Soft money in real estate is the exact opposite of hard money. Its interest rate is lower than average and acquiring it is also easier.
There are many options for Funding Rental Property and soft money is the most commonly used way.
A real property is still used to secure this loan, which means that you need to pledge assets as a form of collateral in the event that a default happens.
This is the reason why acquiring a soft money loan is easier and simpler than a hard money loan.
A soft money lender will also focus more on the credit score.
A soft money loan is essentially a type of financing based on assets combining the elements of conventional loans with hard money loans.
What is the Difference between Soft Money vs. Hard Money?
The major difference between soft money vs hard money is that soft money is more suitable for long-term investments while hard money is usually used for funding short-term investments.
Soft Money vs Hard Money Rule of thumb:
- Hard money
- Short Term Loan
- High fees
- High Interest Rates
- Not based on credit
- Individuals and Companies are the lenders
- Soft Money
- Long Term Loan
- Lower fees
- Lower Interest Rates
- Based on Credit Score
- Banks are the Lenders
A hard money loan is a loan issued by the lending bank known as hard money lenders.
The lenders structure these loans according to the after repair value (ARV) of the subject property and less on the financial strength or credit score of the borrower.
Commercial banks issue soft money loans that are structured based on two primary factors: the credit score of the borrower and their ability to pay every month based on their income.
What is Hard Money and Soft Money Lending?
A hard money loan is a type of short-term bridge loan that is backed by the property’s value against the borrower’s creditworthiness. Private investors often fund these hard money loans.
These also have more strict lending criteria and repayment schedules.
Terms for hard money loans are meant to be shorter and the repayment is owed in a period of 3 to 6 months, which depends on the particular hard money lender.
A soft money loan is defined as a more traditional type of loan with a below-market interest rate. It is a loan with longer interest holidays and repayment periods.
A good example of soft money loans is a car loan.
There are car loans that provide 0% APR for an interest holiday or a certain amount of time with repayment periods that extend from 2 to 6 or 7 years.
Certified lending institutions usually provide soft money loans.
Are Hard Money Loans a Good Idea?
There are several reasons why hard money loans are a good idea for both house flippers and real estate developers.
First is the speed. For these loans, the lenders are not interested in your current financial standing. This means that it requires a lesser background check.
Lenders won’t review your income or bank statement.
Instead, the main concern of the lender is the collateral. This is why processing and closing hard loans is faster compared to conventional loans.
Hard money loans also have flexible agreements. Hard money agreements don’t follow a standardized underwriting procedure.
The deal can be changed according to the requirements of a specific contract. For instance, the repayment schedule can be modified according to your needs.
What is the reason behind this flexibility of hard money loans?
This is because, with hard money loans, you don’t have to negotiate with a corporation. You will only deal with an individual who will more likely understand your situation, something that you cannot expect from giant entities.
If you already experienced applying for a traditional bank loan, you surely know that it is hard to be approved.
In fact, it can be a serious struggle. It is because banks tend to be very strict when it comes to the people they give their loans to.
Banks will check your bank statements, income, debt to income ratio, and credit rating carefully and meticulously before they approve your loan application.
Hard money lenders, on the other hand, only care about the collateral. They will approve your loan according to the property’s value.
There are lenders that don’t care about the credit ratings at all although some might inquire and look into your personal finances.
This is why hard money loans have higher approval rates.
However, hard money lenders deliver extremely low loan to value ratio. For example, you can get 50% of your asset’s value as a loan.
It gives the lender an assurance that they will be able to sell off your property and get their money back if things don’t go well.
What are Hard Money Loan Rates?
The points and interest rates hard money lenders charge can vary from one lender to another as well as from one region to another.
For instance, California-based hard money lenders offer generally lower rates compared to those in other states because there are numerous hard money lending firms in California.
This decrease in prices is the result of the increased competition.
The hard money lender charges a percentage point of the loan when the loan is actually funded. A point would be a percentage of the loan.
1 point = 1 percent of the loan
If you borrow $50,000, then the cost for the loan at 5 points would be 5% of the loan amount.
$50,000 x 5% = $2,5000
Hard money lenders deal with more risks with the loans they offer, unlike conventional bank loans.
As a result of the higher risks associated with hard money loans, their interest rates are also higher compared to conventional loans. Hard money loan rates can range from 10% to 15% and this can depend on the loan’s perceived risk and the specific lender.
Points may range anywhere from 2% to 5% of the amount loaned. The points and interest rates may differ greatly depending on the loans to the value ratio.
Do Hard Money Lenders Require a Down Payment?
Even if the hard money of your lenders will cover most of the associated costs with some repairs and property’s purchase value, you will require cash in hand.
Not every hard money lender requires borrowers to make a down payment on properties, but most of them do.
Some lenders like to see that borrowers have skin in the game before they go into business with them.
In addition to that, making down payment mitigates some of the risks of the lender and may help you achieve an attractive interest rate.
You’ll also require savings to cover the repairs on the property. Other loans may be structured to include the reimbursements for repairs.
But, the borrowers will have to pay cash upfront to get started.
What are the Pros and Cons of Soft Money Loans?
The Good about Soft Money Loans
- Soft money loans have a flexible repayment schedule depending on the credit score of the borrower.
- Once you take out soft money loan, it will be a part of the credit history and may help you repair and build credit.
- Soft money loan may fund up to 90 percent of the LTV of the property.
- Soft money loan has also low interest rates depending on the credit score of the borrower.
The Not So Good about Soft Money Loans
- Soft money loan has longer closing times for 10 to 14 days.
- Aside from showing good credit, the borrower has to prove they have 3 to 6 months worth of loan payment in reserve.
- You should turn over several assets as collateral for the soft money loan.
- You cannot get approved for soft money loans with bad credit.
What are the Pros and Cons of Hard Money Loans?
The Good about Hard Money Loans
- Quick Process. Since you’re working with a small group of lenders or individual lender, there are some hoops to jump through.
A hard money lender isn’t interested in credit score or the total amount of your debt.
They’re only interested on how much value they see in the properties since these will be the asset that would back up the loan. You can have loan in a few weeks or days depending on your lender.
It might take 1 to 3 months to secure a traditional mortgage.
- Traditional mortgages need you to put down 5% of the purchase fee. Some banks prefer you to at least put 20% of the purchase fee as your down, which will provide you better loan terms.
Once you put down less than 20%, you’ll frequently need to buy mortgage insurance that will increase the mortgage payment every month.
- With hard money loans, lenders are willing to lend you 100% of the purchase fee.
Without the down payment, you will only be responsible to pay the origination fee as well as the interest every month until you pay the loan in full.
- If you’ve shown a history that honors the terms of contract and paying loans back on time or every year, the lender would want to work with you in the long run.
Lenders are willing to loan a good percentage of the purchase rate, decrease the time it’d take to get the loan or lessen the origination fee.
- When you’re just starting out, hard money loan enables you to buy property with some of your money.
If you have established yourself as an investor, you can secure a credit line from the bank rather than using hard money loans that would have low interest rate.
- Hard money loan can be processed quickly and may be for as much as 100 percent of the purchase price.
The Not So Good about Hard Money Loans
While there are some perks of getting hard money loans, there are also some disadvantages that you should be aware of and these include the following:
- Hard money loan has higher interest rates compared to the traditional loans.
Lenders can charge such rates because they are aware that borrowers have some financing options only. Interest rate between 10% and 20% are common.
- Since lenders are taking a risk through loaning a lot of money, they like to ensure that you have incentives to pay that back easily.
- Origination fee is the fee that the lenders would charge in processing the loan. It’s the loan’s percentage.
- It’s a riskier investment. That is the reason why hard money lenders try to protect themselves.
Lenders can charge as much as 5 time the normal lender takes. For instance, if a usual bank charges 1% of the loan as the origination fee, the hard money lender might charge 5% of the loan.
- Hard money loan has high interest rate and origination fees. It is also typically short term.
- Since the property is the loan’s guarantor and not you personally, if you can’t pay off the loan, you’ll lose the property.
- While it’s common to have a fifteen or thirty year mortgage, it isn’t the case with hard money loans.
While each contract is different, such loans should be paid back within several years or months. If loans aren’t paid back within the first few years or months, the high interest rate may increase.
Now that you know the pros and cons of hard money loans and soft money loans, it is time to decide which type of loan will benefit you most.
If you are confused with these options, the best thing you should do is to ask around and find out what other people experience from taking a hard money or soft money loan.
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