Hard money loans and mortgages are some of the most popular ways investors secure financing for real estate projects. However, many people use them interchangeably. Sometimes investors throw a dart at several applications to see which sticks. Still, there are better approaches to financing something as substantial as a house, especially with inflation rates peaking post-pandemic.
Are you curious about which financing option is best for you? Do you want to learn the critical differences between a hard money loan and a mortgage? Then, stick around till the end of this article to find out.
One of the key differences between a hard money loan and a mortgage is how they’re both used by borrowers. Investors almost always use the former to purchase a rental property that can earn income as rent. Thus, it is more for people that want to expand their business. On the other hand, mortgages are more familiar to homeowners looking to buy a property specifically for residential purposes. That’s not to say you can’t use one for the other, but other factors often make these scenarios their most popular use case.
Another difference between the two is in their loan terms. Mortgages tend to have broader varying terms, and borrowers can select terms suited to their needs. For example, you could get a short-term loan of 1 – 3 years or a much more extended period of 10 – 30 years. Borrowers also can decide between fixed or variable rates, and often these terms are more rigid.
However, hard money loans are much less traditional and give more room for negotiation. In addition, their flexibility makes them an ideal non-conventional financing solution for purchasing your real estate investment. Although, you still have to work within a limit as many of them are short-term loans lasting from about 6 months to 2 years. But you can tweak other factors like interest, fees, and payment schedules to your taste.
Many investors unable to meet the high standards of traditional mortgages often fall back on hard money loans for financing. Conventional mortgages offered by banking institutions often have a rigorous approval process that takes several weeks for clearance. It can also be tedious as it requires several documents to verify your credibility, such as your income statements, assets and liabilities, employment history, etc. Thus, this system is often biased in favor of borrowers with higher credit scores and more time to spare.
On the other hand, if you’re pressed for time, it’s best to opt for a hard money loan. Private lenders rarely require an in-depth screening and can approve loan requests within days or weeks of applying, even if you have a low credit score.
Regarding interest rates, hard money loans often have a heavier price tag. Remember that these are private loans, and the lenders aim to make a profit. Since they’re more popular amongst people with lower credit scores or those that need short-term loans, the interest rates are subsequently higher. Many investors also take out these loans to finance high-risk ventures like house flips. With rising interest rates on real estate, hard money loans can eventually be expensive.
Thus, compared to hard money loans, conventional mortgages have much lower interest rates. In addition, since investors can spread their repayment across several years, interest rates are lower, and you can incur less interest by making a larger down payment.
Hard money loans and traditional mortgages have unique benefits and drawbacks, so we can’t decisively say which is better. For example, hard money loans are more suited to people who want more short-term flexibility to invest in real estate and might have a lower credit score. Conversely, conventional mortgages are more common amongst homeowners who don’t mind spreading their debt over a long period. With the points we’ve highlighted above, you should consider which works best for you based on your unique situation.
You can contact a pro if you need help deciding which works best for you as a real estate investor. A professional property manager can guide you through these critical differences in-depth and help you decide which suits your needs.