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Commercial Finance

Private Money Loans Versus Hard Money Loans

By November 10, 2020No Comments

You may have heard the term “private money” or “hard money”. But, is there a difference? Finding the answer to them can be difficult. The fact is, there really aren’t any concrete definitions and the difference between the two can be difficult to decipher. The reality is, there isn’t much difference – essentially private money and hard money are loans you get from private individuals or companies when you need to close quickly, but you’ll pay a pretty penny.  

Of course, we all want to get the most competitive financing but for various reasons that might not be possible. So, while you may not think you would ever find yourself getting a private money or hard money loan, they definitely serve a purpose. Let’s take a deeper look at the difference between the two and why one might need to go that route for a future deal. 

Here are some of the reasons someone may need a private money or hard money loan:

  • You need to close more quickly than the traditional 30-60 days (depending on whether you’re buying a commercial or residential property) 
  • You need to close “all cash” to compete with other offers 
  • Traditional lenders aren’t willing to lend on the property in its current state – it’s distressed, uninhabitable, vacant, mid-construction, etc 
  • You need more money than traditional lenders are willing to give

As you may have guessed, there is a trade-off to getting a loan that traditional lenders are willing to lend on. While there are benefits to private money or hard money loans, they are generally expensive – typically the interest rate and the fees are higher, in many cases, significantly higher. 

What is a Private Money Loan?

A private money loan is exactly what it sounds like – a loan from a private person or company rather than a bank. Most times, a person may obtain a private money loan through a company. The company essentially acts as a fiduciary for the investor – they underwrite, fund and service private money loans in exchange for a fee.  

Many active real estate investors may have a direct relationship with a person who lends private money (AKA a person who is lending their own money), this can help to reduce the fees charged by companies who lend private money simply because they are going direct to the source. This isn’t always an easy thing to do, you need a reputation and a track record as a professional investor to earn the trust of a direct private money lender. 

There are inherent risks for both the private money lender and the borrower getting a private money loan. Private lenders are willing to lend on properties that traditional banks aren’t willing to lend on in their current state. That said, these loans are less regulated than traditional banks which poses a risk for the borrower. 

Here are the pros of private money loans: 

  • Qualifying for a private money loan is generally faster and easier  
  • They can close quickly, typically 7-10 days, sometimes faster 
  • They are willing to lend on properties traditional lenders aren’t 

Here are the cons:  

  • These are typically short-term loans 
  • They can be expensive, typically at least 2 points (as a percentage of the loan amount) and beyond  
  • Interest rates are higher than a traditional loan or mortgage

What is a Hard Money Loan?

A hard money loan relies on individuals – usually, the borrower and an investor – agreeing to lend funds on revenue potential (and good faith). Funding for hard money tends to go case by case as it relies on individuals to establish a bank-like agreement.

It is the borrower’s job to do as much research as possible to make the investment property appealing to real estate investors. Once the investor(s) is onboard, the property becomes collateral in the agreement between the lender and the borrower. This allows the borrower to have a sense of financial freedom as the lender sees the financial potential in the property. At the end of the day, the borrower isn’t the only one who sees the potential revenue stream of a property.

There are some inherent risks for the borrower rather than the hard money lender when it comes to acquiring a hard money loan. Unlike private money, hard money lenders tend to take the approach of a home mortgage from a bank. If you fail to repay for an extended period, the property can be seized. 

Here are the pros of a hard money loan:

  • Approval of a hard money loan is quicker than a traditional loan
  • The agreement between the lender and the borrower are generally flexible
  • A borrower has some financial freedom 

Here are the cons:

  • Repayment on a hard money loan is shorter
  • Interest rates are higher than a traditional loan or mortgage
  • The lender can seize the property if the borrower doesn’t uphold the agreement

What’s the Difference?

While their names speak for themselves, here are some of the differences between hard money and private money loans. Hard money is centered on organized lenders acting similar to a loan company. Private money tends to be funds acquired from a family member, friend or private investor looking to get into real estate themselves.

While hard money loans do meet certain criteria and terms of a traditional bank loan, they allow lenders to take on projects deemed “financial risks” by banks and private loan companies. Private money deals with terms both the borrower and the lender work out amongst themselves- without government regulation. 

Which One is Best for Real Estate?

If a borrower is looking to increase a property’s resale value, then, hard money loans may be the best solution. Often times, private money lenders or hard money lenders can give you the additional cash you need to make improvements to the property which, in turn, adds value to the property. While the cost of these loans are typically much higher, it may be only option that will provide you with the funds to make the improvements so you can refinance into a traditional loan or sell the property for a profit. 

If the borrower wants to flip or renovate a property in a short timeframe, then, private money loans are the best option. This allows the borrower to payoff the loan without penalty or triggering a default on the loan as many traditional lenders don’t allow construction (it compromises their collateral). Long-term investment properties may still also need private money, especially when in-place rents are significantly below market. Once you’ve made the improvements and increased the income, you can qualify for a higher loan amount with a traditional lender.

At the end of the day, the private money versus hard money debate comes down to the borrower’s financial position as well as their needs.

At Pacific Shore Capital, we pride ourselves on guiding our clients through the financing process and helping you make the best decision for your needs. For more of our advice and opinions on all things real estate, follow our podcast.

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