In many ways, hard money lending is quite similar to conventional lending. First, you need to apply for a loan. If approved, the lender funds your loan. Over a specific term, you repay the loan with interest.
However, hard money lenders differ from conventional bank lenders in all the crucial details. Specifically, the application process, approval, funding, and loan purpose and terms differ significantly from traditional loans.
In this article, you’ll learn all the crucial differences between hard money loans and conventional loans.
Application Process
In general, hard money loans include an application process that requires less documentation compared to a conventional loan. Moreover, private money lenders require documentation that is often completely different from what private bank lenders need.
Banks
When deciding whether or not to approve your loan, a bank is primarily concerned about your creditworthiness. For that reason, a bank requires proof that you have enough income to repay the loan. They also need a clean credit score because they don’t want to take the risk of lending money to someone who has had problems with repaying debts in the past.
The banks determine your DTI ratio with the help of the information you give to them. They divide your monthly debt repayments by your monthly income to calculate the DTI. The number has to be less than 45% for a bank to consider approving a conventional mortgage. Your average credit score needs to be about 685 to get a mortgage in the United States.
Hard Money Lenders
Hard money lenders are interested primarily in the investment when they decide whether to approve your loan. The most important question for them is if the investment’s value covers the loan should you be unable to repay it. It is the main reason private lenders ask to see a property appraisal as a critical document with your hard money loan application.
The lender divides the amount you’ve requested by the after-fix value (ARV) of the investment to calculate the asset’s LTV ratio. Most lenders prefer an LTV that’s less than 70% because it ensures the borrower has a stake in his project’s profitability and won’t walk away from his loan obligations.
Approval and Funding
Fewer documentation requirements result in hard money loans getting quicker approval than traditional loans. It also means you get the funds much quicker, too. Let’s make a comparison:
Banks
Banks take around a month to approve a loan application. It’s the reason for creating pre-approvals in the first place. A majority of sellers aren’t willing to wait for an entire month for the buyer to find out if the loan was approved or not.
Once the bank approves the loan, you will wait for three more business days to receive the funds. For example, if you get the approval on Wednesday, the closing won’t be scheduled before Monday or Tuesday next week.
Private Money Lenders
Unlike banks, hard money loans have fewer requirements to observe when approving your loan application. Moreover, private lenders are aware that time is essential for real estate investors, especially when they’ve come across a valuable asset. While the loan approval period may vary from one lender to another, some private lenders can approve a loan application and fund the loan within just a few calendar days. Investors involved in house flips find the fast approval and funding process essential when it comes to grabbing good properties on time.
Loan Purpose and Terms
Conventional mortgages usually take 20-30 years to repay. Hard money loans, on the other hand, are repaid over a much shorter period. While loan terms vary significantly from one lender to another, each of them promotes short loan repayment time. The reason for such differences is due to entirely different loan purposes.
Mortgages
Mortgages are created for owner-occupied properties and based on the assumption that the owner will occupy that property for a long time. It results in mortgage payout times going from 15 to 30 years. It’s a way of keeping the payments as low as possible. However, it’s also a way of paying back a loan for a very long period, with the first decade of payments going mostly to interest.
Hard Money Loans
Most hard money lenders specifically deny loans to borrowers who intend to buy owner-occupied homes. With limited flexibility to approve mortgages due to the Dodd-Frank Act, private lenders don’t have the flexibility they need to approve such applications. The regulations restrain the lender’s ability to act promptly or take on the risks of financing investment assets.
The purpose of hard money loans is for investors to get sufficient funds to buy properties they will later sell or generate revenue through rentals. As a result, borrowers often repay hard money loans within six months to two years. The entire structure of the loan gives the investor enough time to monetize the estate and then clear the debt promptly. It saves the investor a lot of time and allows them to apply for a loan for the next investment as soon as they pay off the debt.
