How Do Hard Money Loans and Mortgages Differ?

How Do Hard Money Loans and Mortgages Differ?

The pre-housing-crash hard money industry was known for making all sorts of loans that lenders would never make today. Our industry has changed quite a bit as a result of the aftermath of the crash, especially where the Dodd-Frank Act relates to property funding. Unfortunately, some people still conflate hard money loans with mortgages because they are ignorant of how much things have changed.

If you are a seasoned real estate investor, you probably don’t need an explanation of the differences between hard money and mortgage lending. But for everyone else, a brief summary of those differences could be helpful. So without further delay, here they are:

1. Different Purposes

Every loan has a purpose. When a borrower goes looking for a loan, the lender generally asks what the money will be used for. The purpose of a mortgage is pretty simple, so we do not have to go through that. As for hard money, its purpose is entirely separate.

Hard money lenders provide loans to borrowers looking to obtain commercial property. A loan might be offered to an investor looking for property to purchase and rent. Another loan might go to an investor who hopes to improve an acquired property before selling it. Still another loan might go to a business looking to obtain property in order to expand.

2. Dodd-Frank Requirements

The Dodd-Frank Act, signed into law in 2010, put onerous restrictions on banks related to proving a borrower’s financial position prior to funding a loan. The intent of the act was to reduce the chances of another housing crash. Its restrictions forced the hard money industry to narrow its focus significantly.

Because hard money lenders typically lend to real estate investors and businesses, our loans are not subject to most of what the Dodd-Frank act requires of traditional banks. For instance, hard money loans are asset-based loans. Therefore, lenders do not have to jump through hoops to prove a borrower’s financial position.

3. Loan Terms

Another significant difference between hard money lending and mortgage lending is the typical loan term. Mortgage lenders tend to offer terms of 15, 25, and 30 years. There is some variation in that. Hard money lenders work on much shorter terms. This is by design.

A hard money loan is intended to be a short-term loan with a definitive exit plan. Some hard money loans can have terms as short as six months. Rarely do terms exceed two or three years. A borrower certainly won’t be able to get a 30-year term on a hard money or bridge loan.

4. Interest Rates

Interest rates are a big thing for both borrowers and lenders. In the hard money industry, interest rates tend to be higher because the risk is greater. How much higher? We cannot say inasmuch as interest rates are constantly changing. But for all intents and purposes, hard money rates are higher than standard mortgage rates.

On the upside, the total amount of interest paid on a hard money loan, in real dollars, can be less than what is paid on a mortgage. It is the term that makes the difference. Paying 5% over 30 years will add up to more total interest than paying 10% for one year. So even though interest rates are higher, borrowers are not necessarily paying more in real terms.

Hard money loans and mortgages are distinctly different financial products. They have different purposes, they target different borrowers, and they differ in terms of borrowing requirements, loan processing, and rates and terms. Now that you know, there is no more need to confuse the two.