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Hard Money vs. Private Money Loan: Everything You Need To Know

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Hard money loans and private money loans are a type of asset-based loan that lend against real estate collateral. Asset-based loans are short-term, ranging from 12 – 36 months, and serve to fill opportunity gaps left behind by traditional mortgages.

Hard Money vs. Private Money: Overview

Both hard money lenders and private money lenders place more weight on the quality of the real estate asset, than the borrower’s creditworthiness. They also require minimal documentation and can fund deals very quickly.

However, the key difference between a hard money lender and a private money lender is how they manage their appetite for risk and how that translates to the pricing and leverage they offer.

Let's explore hard money vs. private money loans in more detail.

What Is Hard Money?

Put simply, "hard money" is any loan collateralized by a "hard" asset. Hard assets are typically assets that have real-world value, such as real estate, vehicles, gold, and silver. They're contrasted with soft assets, which are typically intangibles like stocks or bonds. In this article, we will be primarily discussing loans collateralized by real estate.

Hard money loans, therefore, use the value of underlying hard assets to structure loans terms such as loan-to-value, interest rates, and fees.

For example, let’s say a real estate investor has a property in their portfolio that they would like to sell. However, the property requires renovations before they can put it on the market. A hard money lender can lend against the property and provide fast financing, so the property owner can get the funds they need to make the necessary renovations to maximize their earning potential when they sell. This is also known as a fix-and-flip, and is a common investment scenario that hard money lenders cater to very well due to their speed and no income verification.

Two Advantages of Hard Money

  • Quick To Receive Approval
  • Good for House Flippers

There are some advantages to using hard money for real estate investing. For example, hard money loans are usually faster to approve. They don't abide by the same loan regulations enforced by an individual or private lenders/institutions.

Additionally, if you are looking to invest in a fixer-upper, a hard money loan can give you the capital you need to secure your next fix-and-flip project efficiently.

Two Drawbacks of Hard Money

  • Higher Interest Rates
  • Pre-payment Penalty

That said, there are some potential downsides to hard money loans. Since hard money lenders do not asses the sponsor’s creditworthiness, they will aim to maintain a higher pricing to compensate for any unknown risks. Therefore, hard money loans typically have higher interest rates and fees than other asset-based lenders.

A hard-money loan can also have a pre-penalty fee if you decide to pay your loan off early. The cost of a pre-payment penalty fee varies from lender to lender and can either be a percentage of your balance or a lump sum. Keep in mind that a reputable hard money lender will be able to let you know upfront if there are any fees associated with paying your loan off early.

What Is Private Money?

Private money is a short-term loan provided by a private lender, instead of a traditional financial institution. A private money lender will lend to companies or individuals for commercial-use, primarily for the purchase or refinance of an investment property.

A private money loan offers fast financing and is meant for shorter time frames than a traditional loan. It is a great option for real estate investors who need to close on a deal quickly, but need more time to qualify for a traditional 30-year mortgage.

A private money is also a good option for certain asset types that are not eligible for traditional financing, such as land and non-warrantable condos.

For example, let’s say an investor is under contract and has made deposits towards the purchase of a pre-construction luxury condo. However, the building has not yet received Fannie Mae approval and the investor’s unit is considered non-warrantable, meaning it does not qualify for traditional financing.

If the investor does not come up with the remaining 50% required to close, they are at risk of losing their contract and deposits. In this case, a private money loan is an ideal solution for an investor who’s financing fell through at the last minute or they have their money tied up in other investments.

Two Advantages of Private Money

  • Better Pricing
  • Good for Pre-Construction Condo Investors

Like hard money loans, private money loans have some advantages. They don't require income documentation, for starters. Thus, they are excellent financing options for foreign nationals or borrowers who can't verify all their income. As a private lender, Vaster also offers this benefit.

Some private money lenders will also factor in the financial strength and investment experience of the borrower to offer better terms and pricing, in addition to the collateral being a high quality asset. 

In addition, private money loans are a great option for pre-construction condo investors that want to close on their purchase as quickly as cash could, while they wait for Fannie Mae approval to secure a traditional loan or a payout from another investment.

Two Drawbacks of Private Money

  • Liquidity Requirement
  • Doesn’t Cater to All Fix-and-Flip Scenarios

Private money loans similarly have their downsides. Firstly, they typically require some liquidity on the borrower's part. That means the sponsor must show enough liquidity to cover at least 6-months of interest payments.

On top of that, private money lenders typically do not cate to all fix-and-flip scenarios, particularly assets that are incomplete or require significant improvements. Instead, a private money lender will opt to lend on the value of the land or when a project is fully completed.

What Do Hard Money and Private Money Have in Common?

Both hard and private money loans are asset-based loans, meaning they are secured by real estate and primarily focus on the quality of the asset than the borrower’s creditworthiness.

Additionally, both hard money and private money are short-term loans ranging from 6 to 36 months and are intended for commercial-use only. This means the borrower cannot use the property as a primary residence or second home.

The Bottom Line: Which Loan Is Best for You?

Neither hard money nor private money loans are better than the other. Instead, which is better for your situation depends on what you want to purchase, your current financial situation, and whether you have collateral assets to put up for a loan.

If you're looking for a customized and flexible mortgage financing solution, Vaster can help.

Our experienced loan officers can provide a custom financing solution that is catered to your purchase or refinance needs. Contact Vaster today to learn more.

Sources:

Hard Money Loan Definition | Investopedia

Collateral Definition, Types, & Examples | Investopedia

Liquidity Definition | US News

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