There are a lot of loans available these days and the most popular are the ones offered by traditional lending sources like banks, mortgage companies, and various government institutions. Aside from the standard loans, alternative lending options are also available like hard money loans or private loans offered by hard money lenders or private lenders, groups, and companies. Private loans differ in so many ways with conventional loans offered by banks.
If you are thinking of getting a loan for personal, business, or investment purposes, then it is important to have proper understanding about standardized loans, private loans, and their differences.
Comparing Hard Money Loans and Conventional Loans
Basically, loans are different from each other since terms and rates can differ from borrower to borrower depending on their qualifications and their needs, the market condition, state laws, and more. To make things simpler especially for those who are just starting to understand the concept of private and conventional loans, hard money loans or private loans and conventional loans can be properly compared loosely using general guidelines.
We can compare these two common types of lending options through the factors involved in these loans.
- Credit: For conventional loans, credit of borrowers should be good or even excellent to achieve better rates and terms. The credit worthiness of a person can affect the amount of loan he or she can borrow, the points, the interest rates, and other terms of the traditional loans offered by banks. For private loans, any credit, good or poor can qualify for these types of loans. Most private lenders give little or even no importance to the credit score and record of the borrower. In terms of credit, private money loans are definitely preferable than conventional loans.
- Income: Banks and other standard loan providers require complete financial information especially personal income of a person. This information must be verified first even before your loan application can be processed. With hard money loans, personal income verification is usually not a requirement. However, some private lenders would verify especially large private lending companies operation nationally.
- Interest Rates: Conventional loans usually come with lower interest rates ranging from 5% to 8% especially if the borrower has good credit rating and can present real assets to back up the loan. Private loans on the other hand, come with higher than average interest rates ranging from 8% to 15% making these kinds of deals more costly than traditional loans.
- Points And Fees: Points for traditional loans can range from zero to two while private loans are higher which can range from two up to ten points.
- Term: Traditional loans are usually long-term loans with the duration ranging from 10 years up to 40 years. Hard money loans on the other hand are also called short-term loans basically because of the short duration of the loans. Private loans terms can range from few months to 5 years.
- Processing Speed: Standard loans offered by banks are sometimes really time-consuming and difficult to process especially if your qualifications are not that good such as your credit scores. Speed of processing for standard loans can reach 1 month up to 3 months.
- With a poor creditworthiness, you cannot even guarantee loan approval. Private loans can be processed and approved fast, usually within weeks while some hard money lenders can even grant loans within a few days. If the property or real assets presented are profitable, you have high chances of getting your loan approved by your private lender.
- Other Assets: Stricter banks and lending companies would usually also verify other assets of the borrower to ensure that the person can properly secure the loan. This makes loan application in banks really hard especially for those with little assets and with not-so-good credit background. Hard money loans on the other hand usually do not require verification of other assets of the borrower. If the property used as collateral is enough to secure to loan, no need for other asset verification.
- Equity: Standard loan applications usually impose zero up to 20% equity only while private loans may require higher equity from 35% or even higher.
- Loan To Value Ratio: Loan to value ratio for standard loans are higher since banks can lend up to 100% of the market value of the appraised property. Hard money loans on the other hand usually have lower loan to value ratio or LTV compared to standard loans. Hard money lenders can only approve loans with 65% loan to value ratio up to 85%. Some private lenders may also grant higher percentage depending on the various factors and the negotiation between parties involved.
- Purpose of the Loan: Just like for personal income and assets, the purpose of the loan also needs to be verified if you are borrowing money from standard financing institutions like banks making loan application a bit difficult. For private loans, the purpose of the loan is not required to be verified and borrowers can use the funds for any purposes, which are mainly real estate investments, refinancing, and immediate solution to short-term financial problems.
Hard Money for Commercial Purposes
Commercial hard money loans are similar in various factors to the traditional private loans provided for individuals. However, commercial private loans can be really more expensive compared to individual private loans basically because of the higher risks involve in commercial transactions. Since most commercial loans offered by hard money lenders are short-term, these kinds of loans are also popularly known as bridge financing or bridge loans.
Just like with private loans for individuals, commercial hard money loan programs are also not restricted to the standard loan guidelines imposed for commercial properties. Processing of commercial hard money loan is also faster and easier compared to the traditional commercial loans from banks. However, since commercial hard money loan programs are riskier and have higher default rate, borrower should also expect higher than average rates, points, and terms.
If the borrower defaults on the bridge financing or hard money loan, the property can face foreclosure. The borrower may not be protected and gain assistance from bankruptcy policies if he or she already filed bankruptcy before.
Cross Collateralization or “Blanket Mortgage”
In some cases, the value of the property involved may not be enough to secure the hard money loan. If this happens, cross collateralization may be required by the lender wherein more than one property can be used to secure the loan. This kind of loan transaction is also called “blanket mortgage”. Cross collateralization is not common for individual or homeowner private loans because individual borrowers usually have limited or only one asset to back up the loan.
Blanket loans are rather very common in commercial hard money loans since borrowers who are applying for commercial loans have more than one property or real asset that can be used to secure the loan. If the commercial property is not enough to secure the commercial hard money loan, the borrower can use his personal assets as cross collateral to properly secure the loan.
A Little History About Hard Money
Hard money is a term exclusively used in Canada and United States since these are the countries where private lenders are operating. When the industry begun in 1950s, hard money lending was a positive lending practice providing real estate investors and borrowers an alternative or “last resort” to fund their projects. However, during the 1980s and 1990s, the country experienced real estate crashes resulting to big losses for hard money lenders due to overestimation of properties and overfunding of real estate transactions.
After recovering from the market crash, most hard money lenders started to provide hard money loans with very low LTV or loan to value ratio. Through lower LTV ratios, they can reduce the risk and protect their investments from unpredictable market conditions. Through time, hard money lending has greatly evolved and aside from lower loan to value ratio, hard money lenders also found additional protection from risky transactions by imposing higher than average interest rates.
Regulation Issues on Hard Money Lending
Hard money loans are often structured using non-standard loan guidelines imposed by the regulating bodies. This is why this practice often faces issues regarding legality and regulation violations. However, private or hard money lending industry has been unregulated by various states and federal laws although there are some states that impose laws regarding standard interest rates for hard money loan programs to protect borrowers from lending predators and shark loans.
Since the private lending industry is unregulated, it is the responsibility of borrowers to make careful decision when borrowing money from private lending firms. Although there are many private lenders who are lending money only to take advantage of the borrowers’ difficult situations, there are also a lot of good hard money lenders who are operating not to take advantage but to gain profit by helping borrowers become successful with their investments and businesses through their funding.
It is just a matter of researching well about what you are getting into so you know what to look for and how to find good and trustworthy private lenders, and hard money loans with reasonable rates and terms.