Hard money lenders and private lenders have their similarities; however, they do have some notable differences. Let’s take a look at what makes hard money lenders and private lenders unique.
If you are a real estate investor searching for another way to finance a purchase, fix & flip, hard money or private loans are a few great options. Going with a traditional loan to flip a house or purchase a rental property can be challenging, and other financing options may be better suited to your needs. Which option is the best match for your needs? We’ll help you decide by taking a look at the differences between hard money lenders versus private lenders.
What is a hard money lender?
Hard money lenders provide short-term mortgage loans to borrowers who are investing in flipping or commercial real estate. Hard money lenders typically do not have conventional loan terms; they are provided by individual lenders or private companies who are not part of a financial institution. Hard money lenders are also referred to as asset-based lenders, meaning the property itself is used as collateral for the loans. However, a minimum FICO score of 620 or higher is required.
Hard money lenders are typically less concerned with the borrower’s “flip” history and more focused on the real estate deal itself. This allows a hard money lender to offer fast funding to borrowers because there’s less red tape than traditional loans. Hard money lenders aren’t institutionalized and can therefore make their own loan approval requirements; they will even fund ‘newbies’.
Hard money lenders can give 80% to 100% of the purchase price of a home and up to 70% of after-repair value (ARV) of a property. Where does a hard money lender source their funds? They receive funds from a variety of sources, including private individuals, who will often receive a more handsome rate of return due to the riskier nature of the investment. To mitigate this risk, hard money lenders charge higher interest rates on their loans.
What is a private lender?
A private lender usually is a wealthy individual or a private organization that provides loans to real estate investors. These lenders don’t adopt traditional lending criteria because they are not affiliated with any financial institution, such as a bank. What does this mean? Lending can be more flexible. In fact, private lenders don’t subscribe to any particular set of loan terms or criteria and are free to do as they please when it comes to lending.
Private money loans are also asset-based loans interested less in the borrower’s financial standing and more in the property. Private lenders are not traditional lenders and are not typically licensed to lend money, whereas hard money lenders may be.
Here’s an example: a private lender is a family member, friend or referral who has enough money to help you fund your flip. Or, a wealthy individual that you’ve met that is going to help fund your next property purchase with established repayment terms. A private lender can, quite literally, be anyone as long as they have the money; their lending criteria is entirely up to them.
Hard money lenders vs private money lenders –
what’s the difference?
The major differences between hard money lenders and private money lenders are:
- Loan terms: Hard money lenders have more rigid lending criteria than private money lenders. Hard money lenders will generally stick to certain rules around the points, interest rates and terms of the loan, whereas private money lenders can be flexible on every aspect of the loan.
- Licensing: Hard money lenders are licensed to lend money, whereas private money lenders are not typically licensed to lend money.
- Locating the lender: Because they are widely advertised, hard money lenders are easier to find than private lenders, who don’t typically advertise themselves. Finding a private lender can be more of a challenge and they will more than likely need to find you or be found by referral.
Advantages & disadvantages of using a hard money lender
Advantages
Flexible loan terms: Hard money lenders dictate their own rules about the loan terms, this means that they have the ability to be more flexible. Sometimes, loan terms can be negotiated and can change depending on the borrower’s circumstances.
Fast funding: Hard money loans often close much faster than traditional loans, sometimes in as little as a few days. Quick access to funds ultimately gives borrowers an advantage over their competition.
Credit score is less important: Borrowers do not need to worry about having an excellent credit history when it comes to hard money loans due to the success and profitability of the real estate deal being a hard money lender’s primary focus. Borrowers can concentrate instead on finding a worthwhile property deal and even if their credit history isn’t stellar, potentially still qualify for a hard money loan.
Less paperwork: Hard money lenders offer borrowers a faster and easier overall process, requiring less paperwork than a traditional loan. One reason they can provide this expedited service is because they are not bound by the same rules and regulations. Another is due to the underwriting process being less rigorous than a conventional loan; the property itself is used as collateral for the loan, and this is where hard money lenders are able to save time.
Disadvantages
Property is used as collateral: Because the asset (usually property) is collateral on a hard money loan, borrowers run the risk of their hard money lender seizing their home if they are unable to make their repayments toward the loan.
High interest rates: In order to mitigate the risk associated with hard money loans, lenders will often charge higher interest rates than those associated with a traditional loan. Anything from 10% to 12% is what borrowers can expect to pay on typical hard money loans depending on the lender.
Shorter loan terms: Hard money loans are most often anywhere between 6 and 24 months long. Some longer-term hard money loans do exist, but the short-term loans are more customary. This can be disadvantageous for some borrowers who may require a long-term loan with lower interest rates.
Hard money lender or private lender – which should you choose?
Using a hard money lender:
There are 3 types of borrowers who will generally work with a hard money lender to fund their projects:
1. Real estate investors who are flipping homes and need access to funds quickly.
These investors will pursue a fix and flip loan with hard money lenders and, generally, only pay the interest for the duration of the loan until the end, when a balloon payment is due for the principal amount. This option is suitable for flipping investors; they only need to pay off the interest while they are repairing and renovating the house, then they can sell it to make the balloon payment. Hard money loans offer fix and flip investors the opportunity to acquire funding quickly, which can give them an edge over the competition.
2. Rental property investors who are buying properties to rent out to tenants.
Those who are buying properties with the intention of renting them out will often need enough money to purchase the property and potentially renovate it. But, they will also likely be able to pay the loan back over a longer period. Hard money lenders do not only offer short-term loans, they can also finance long-term loans for this particular purpose. For example, 44 Oak Capital offers a 30-year fixed loan for rental properties.
3. Developers who are doing ground-up construction projects.
Developers who are building properties may require hard money loans to get their project off the ground. These can come in handy for a cash injection to get a project started. These loans can be a better option for builders who need fast access to funds with no hard credit pull.
How about a private lender?
Anyone who needs money for a business venture can use a private lender. In the case of real estate investing, this can include anything from fix and flip to buy and hold strategies. Because private lenders don’t advertise, they are usually found by referral. If you are in need of funds for a real estate project, and are unable to get a conventional loan due to bad credit or any other reason, a private lender could be a good solution for you.
Final thoughts on hard money lenders vs private lenders
Before signing on the dotted line for either loan type, ensure that you’ve done your homework to determine which loan is best suited to your specific real estate needs. Every lender is different; weighing the risks against the benefits is the best strategy to choose which type of lender will be able to provide the best financial solution for you.