While there is a myriad of financing options available for those looking to purchase or invest in real estate, today we’ll zero in on two distinct choices: hard money loans and traditional financing. This article aims to break down their key differences, and examine their unique advantages and drawbacks for different property types and borrowers.
Conforming vs. Non-Conforming Loans: Setting the Stage
First, it’s crucial to distinguish between “non-conforming” and “conforming” loans. Hard money loans are non-conforming, meaning they don’t meet the set criteria by federal agencies like Fannie Mae and Freddie Mac. These agencies back most traditional, or “conforming,” mortgages because they adhere to set standards like loan limits and borrower qualifications.
The Five Key Differences
1) Funding Sources
Traditional loans are typically issued by regulated financial institutions such as banks and credit unions. Hard money loans, in contrast, are often financed by private investors or smaller lending companies. The informal nature of these lenders provides the flexibility that makes hard money loans unique, albeit often more expensive.
2) Time Frames and Low-Down Payments
The agility of hard money lending is one of its most attractive features. While traditional financing can take upwards of a month or more to close, hard money loans can be completed in as little as two weeks, or even less in some cases. Additionally, hard money loans generally require a lower down payment, allowing borrowers to secure their financing quickly.
3) Loan Requirements and Terms
Conventional loans involve rigorous credit checks, income verification, and a host of other qualifications. Hard money loans, however, bypass many of these requirements, focusing instead on the asset’s value. They are generally short-term and interest-only. The term “interest-only” means that the monthly payments you make only cover the interest that accrues on the loan amount; the principal remains unchanged.
4) Interest Rates
Expect to pay a premium for the convenience and speed of hard money loans. These come with significantly higher interest rates, sometimes double those of traditional loans, as the lenders are taking on more risk.
5) Property Requirements
Traditional loans are primarily for owner-occupied homes that meet a specific set of quality criteria. Hard money loans, conversely, are ideal for rehab or distressed properties with no or minimal property requirements, positioning them as a favorite among investors rather than homeowners.
Appraisals: A Different Ball Game
Traditional loan appraisals focus on Debt to Income (DTI) ratios, which is a measure of a borrower’s monthly debt payments to their gross monthly income. Hard money, on the other hand, is all about the Loan to Value (LTV) ratio, calculated by dividing the loan amount by the property’s After Repair Value (ARV). LTV is crucial for hard money lenders as it assesses the risk associated with the loan based on the property’s value, both in its current state (“AS IS”) and its projected value post-repair (ARV).
For those seeking a nuanced and expert appraisal, Boston Appraisal Services has unique expertise in construction, investment, and development. Whether you’re an investor or a hard money lender, you can rely on our specialized knowledge to guide you through your real estate journey.