Many professional real estate investors avoid using conventional mortgages and choose to use hard money loans for their investments. Instead of a bank issuing the funds to secure an investment, private investors issue the funds on hard money loans. Also known as short-term bridge loans, hard money lenders are more concerned with the value of the investment property than they are with the borrower’s credit score.
Conventional Mortgages vs. Hard Money Loans
There are several key differences between conventional mortgages and hard money loans. First of all, hard money loans carry repayment terms that can last anywhere from two to three months up to 12 months, which is why they are commonly referred to as short-term bridge loans. The interest rates hard money lenders charge are usually far higher than what traditional banks charge for conventional mortgages. Since borrowers of hard money loans are using the funds for real estate investment purposes, hard money lenders take on more risk than traditional banks. However, many borrowers are willing to pay higher interest rates and fees on hard money loans because of the benefits of the loan.
Hard Money Loan Benefits
Professional real estate investors and wealthy investors often forgo conventional mortgages and use hard money loans despite the higher interest rates and fees. Here are a few reasons why investors often choose hard money loans:
- Hard money loans are convenient. Qualifying for a conventional mortgage is a challenging and time-consuming process. Many real estate investors are working on tight schedules and often do not have the time to wait on the approval process to close on a real estate deal.
- Hard money loans offer flexible repayment terms. Since hard money lenders are private investors, borrowers have more room to negotiate repayment terms. For example, some hard money lenders will approve financing based on the appraised value of the subject property after repairs, which is known as the after repair value (ARV).
- Many hard money lenders approve financing based on the value of the real estate investment alone. When borrowers apply for conventional financing, they must meet specific debt-to-income ratios, credit scores, income requirements and several other qualifying factors. Hard money loans allow real estate investors to close quickly on their investments.
The bottom line is that hard money loans and conventional mortgages serve two different purposes. Although real estate investors can secure financing using conventional mortgages, first-time homebuyers cannot use hard money loans to secure financing on their first home. The takeaway is that private investors provide the funds for hard money loans while traditional banks and mortgage companies provide the financing for conventional mortgages.