If you’re seeking a short-term loan to purchase, rehab, and rent a house, you may find the terms of a conventional mortgage to be too long. Or maybe your credit score or your financial past disqualifies you from a traditional loan. Fortunately, a tried-and-true funding source is gaining popularity among real estate investors: Hard money lenders.
But before you decide whether hard money is right for you, it’s important to know the differences between hard money and traditional mortgage loans. This article will walk you through the different aspects of a loan and compare hard money and conventional mortgages.
Qualifying for a loan
Conventional mortgage
The loan approval process for traditional lending institutions like banks or credit unions is lengthy and tedious. Here are just some of the factors the lenders consider:
- Down Payment: To avoid paying for private mortgage insurance, you’ll likely need a 20% down payment.
- Credit Score: Ranging from 300 to 850, a credit score is a rating that measures a person’s likelihood to repay a debt. The minimum score to qualify for a mortgage is generally 620.
- Income: Technically, there’s no minimum income required to apply for a mortgage. But your income can limit the amount you’ll qualify for.
- Debt-to-Income Ratio: The DTI is calculated by dividing all your monthly debt payments by your gross monthly income. Many lenders require a DTI of 43% or lower.
- Assets: Assets can include cash accounts, retirement accounts, stocks and bonds, cars, boats, RVs, jewelry, artwork, and collectibles. You’ll be asked to provide proof of ownership and value, such as appraisal letters.
- Documentation: Items you need to provide include tax returns and W-2s (or other evidence of income) from the past two years, statements from bank accounts and/or investment accounts, and your rental history and contact information.
Hard money loan
Private money lenders like Black Brook Capital, on the other hand, have more straightforward criteria. While our loan application does include the credit score, the main considerations are:
- How much will the property be worth after it’s rehabbed—the after-repair value (ARV)?
- Does the applicant have property rehabilitation experience?
- Does the applicant have a solid project plan?
Funding source
Conventional lenders typically sell your mortgage loan to a larger bank or other investors after close. This can be unsettling for first-time homebuyers.
But at Black Brook Capital, all our loans are kept in-house, which offers us flexibly that conventional lenders can’t match.
Time to close
A conventional mortgage lender closely examines the applicant’s full financial standing and history. Because mortgages are longer-term investments, there is less urgency for the lender. Approval generally takes several weeks.
But hard money lenders focus on the property itself and the applicant’s rehab experience. And we realize that time is money in real estate investing. With a simpler application comes quicker approval—often less than a week and rarely more than 14 days.
Loan term
Mortgages are longer loans that can be anywhere between 5 and 30 years. Flexibility is limited to fixed or adjustable rate and the length of the loan.
But a hard money loan is usually short term, ranging from 6 to 24 months in length, depending on the loan type and the lender.
For example, fix-and-flip loans may require only the interest to be paid for a period of the loan, and then a balloon payment of the remaining principal amount at the end.
Interest rate
Conventional mortgage lenders can offer a lower interest rate than hard money lenders because borrowers will be repaying the loan over a longer period.
A hard money loan carries a higher interest rate because of the higher risk of financing a distressed property and the shorter duration of the loan.
Property type and purpose
Traditional mortgages are generally approved for properties that are either single-family or multi-family properties. The borrower is the owner who intends to live at the property.
On the other hand, private money lenders support residential or commercial properties that the owner intends to rehab and rent or sell.
When you should use a hard money loan
Hard money loans are well suited to real estate investors who need fast funding to beat the competition on a deal. They’re short-term loans that often only need the interest to be paid until the balloon payment at the end. So they are well suited to fix-and-flip projects.
These loans can be used to purchase and renovate an investment property, during which the interest can be paid, and the principal amount can be covered once the house has been rented and later sold.
For investors who don’t qualify for traditional loans or need financing faster than other financial institutions can provide, hard money loans are a great solution.
When you should use conventional financing
Traditional mortgages are mostly used by those who plan on living in the house that they’re buying. These loans are geared for borrowers who are planning on paying off the loan in a gradual pace with the principal amount plus interest every month.
Conclusion
Both traditional loans and hard money loans have their pros and cons. Be aware of each and weigh these up against your personal goals and financial situation. This will help you make the best decision for you and your family, or your real estate investing journey.
When you’re ready to explore your first hard money loan, contact us at Black Brook Capital. As experienced hard money lenders, we will walk you through every step of the process.
