Real estate investors who need financing either opt for hard money loans or conventional mortgages. Most individuals, however, do not understand the concept of the former. Both these financing options have their own set of advantages and disadvantages. A deeper look at the nature of these options can help investors decide what is better for them according to their own situation.
New real estate investors should especially avoid mistakes and ensure that they have done sufficient research before taking any step. Understanding the different implications of various financing decisions can aid investors in the decision-making process.
What is a Hard Money Loan?
A hard money loan is typically a short-term loan secured by collateral such as real-estate. Usually, these loans have a term of one year or less. They are funded by private investors who want to earn returns through the interest charged on hard money loans. These hard money lenders are typically more concerned with the value of the property. Due to this such lenders are willing to bear more risk and lend money compared to banks and credit unions.
Anyone seeking a fast financing option would consider a hard money loan. While a mortgage may take significantly longer, a hard money loan may be processed within a shorter time frame. This is why such loans are preferred by real-estate investors who want to raise capital quickly. Hard money lenders usually want the borrower and security to qualify so that the hard money loan can be processed.
A loan shark is also a type of hard money lender who charges very high-interest rates in violation of usury laws. This breed of hard money lender may rely on threats to extract repayments. Though it is true that all loan sharks are hard money lenders, not all hard money lenders are loan sharks. Hard money lenders who comply with usury laws also exist. It is important to evaluate the reputation of the lender properly before making any serious decision.
Individuals with a credit issue might still qualify for a hard money loan because the loan is secured. Hard money lenders bear a higher risk than banks or credit unions. That is why they charge a higher interest rate. In fact, the rates for such loans start at 7.7%. When an investor wants quick and easy access to capital, such a loan is the better option.
What is a Mortgage?
A mortgage is a debt instrument due to which the borrower is obliged to pay back with a predefined set of payments. This sort of instrument is secured by the collateral of real-estate property. Usually, investors who do not want to pay the entire value of the property up-front, opt for a mortgage. Since the term of a mortgage is usually thirty years, it is a long-term debt instrument.
There are many different types of mortgages like fixed rate mortgage or adjustable rate mortgage. Individuals usually have a better understanding of what a fixed rate mortgage is. In the case of a fixed rate mortgage, the borrower pays the same interest rate for the entire term of the loan. Another name of a fixed rate mortgage is a conventional or traditional mortgage. On the other hand, in an adjustable-rate mortgage, the interest rate is only fixed for a certain amount of years. After the fixed initial period the rates fluctuate with the market interest rates.
Most individuals remember the US mortgage crisis of 2008 which eventually led to the Financial Crisis of 2008. After the crisis, getting a mortgage deal became significantly harder. Real estate investors who faced foreclosure or have a history of credit issues, may not qualify for a mortgage. It is important to consider timing when evaluating the financing decision. Even though mortgages are the cheaper and supposedly ‘safer’ option, they might take too long for a real-estate investor. A mortgage can take up to several weeks to process completely.
It is banks and investors who collect and pool funds from lenders for conventional mortgages. It has already been established that mortgages typically take several weeks to process. This delay may not be acceptable in cases where the property seller wants to seal the deal sooner. Since processing time is a crucial factor in real estate, mortgages are a little less appealing. However, even though mortgages may take longer than hard money loans, their interest rates are always lower. These lower interest rates may serve as an additional benefit of mortgages.
Real estate investors should understand the financing decisions they take. New real estate investors should especially be careful and aware of the implications of their decisions. A hard money loan may be better for an investor who is looking for a short-term loan. A mortgage may be better when the timing is not a critical factor, and the borrower has a clean credit history.