Hard Money vs Conventional Financing: Full Comparison
Choosing the right form of financing for your commercial real estate investing is very important, both in the short and long run. However, with tens of options, it might not be easy to sift the suitable form of financing from the not-so-right ones.
So, let’s go through hard money vs conventional financing. To know what kind of loan you choose to finance your commercial real estate property, you should decide if you prefer to work with commercial real estate hard money lenders or conventional lenders.
Hard Money Loans
What is a Hard Money Loan?
Hard money loans have advantages over conventional loans. Some real estate investors who can’t qualify for a traditional bank loan will rely on a hard money loan. When reviewing your loan application, a private lender will assess the property’s value, and what is also important, they will analyze the borrower’s investing experience. Lenders will pay less attention to an applicant’s credit score or ability to repay the loan before providing capital.
Hard Money Loans Requirements
1. Down Payment / Equity
One of the main requirements for getting a hard money loan is having the required down payment or equity in the property that will serve as collateral for the loan. Usually, the minimum amount generally ranges from 25-30% for residential properties and 30-40% for commercial properties.
2. Cash Reserves / Overall Financial Strength
Another requirement to get a hard money loan is having the necessary cash reserves to make the monthly loan payments as well as other holding costs. They usually include insurance, taxes, HOA payments, or other payments that must be taken care of while the borrower owns the property. The higher the number of cash reserves the borrower can show, the greater the likelihood the hard money loan will be approved.
3. Exit Strategy / Experience in Real Estate
The hard money lender will also need to know about the borrower’s experience in real estate. For example, a 25-year real estate investing veteran will generally have an easier time obtaining a hard money loan than the borrower trying to finance their first fix and flip project.
Hard Money Loans Rates
The interest rates for hard money loans differ from lender to lender, but the typical interest range is 8-15%. The interest charge is based on current market rates, and the rate usually does not move up and down with the federal funds rate.
Pluses of Hard Money Loans
- Faster Approval Process
Borrowers can get a hard money loan really quickly (usually from 24 hours up to 10 days). However, the quick return makes them more desirable to sellers. In contrast, conventional loan applicants may have to wait two months or even more to get approval.
- Approval Is Based On The Property, Not On Credit History
A low credit score won’t have an impact on securing a loan. On the contrary, hard money lenders focus on the property’s value. As a result, they have less strict requirements for credit scores and debt-to-income ratios.
- More Flexibility
Hard money loans fasten the entire process. Thus, real estate investors can buy fixer-uppers and get back to work. In addition, fast entries lead to fast exits since real estate investors can fix the property sooner and don’t wait for a conventional loan.
- Tax Benefits
Real estate investors pay significantly reduced overall taxes as insurance, commissions, repairs, and depreciation become the tax deductions.
Minuses of Hard Money Loans
While hard money loans have advantages, consider these disadvantages before taking out a loan:
- High-Interest Rates
Higher interest rates mean higher monthly payments. For example, hard money loans usually have interest rates of 8 – 15%.
- Short Terms
Most homebuyers get 15 or 30-year mortgage loans from a traditional bank. However, spreading the debt repayment over many years minimizes monthly payments. In addition, hard money loans have 1-3 year terms, making them much shorter than conventional loans.
- Additional Fees and Holding Costs
Monthly payments aren’t the only costs you will have to pay to a hard money lender. You will also have to pay origination and underwriting fees. Remember that these fees are more expensive for hard money loans than conventional loans since the first ones are riskier.
What is Conventional Loans?
A conventional loan is a term you use when shopping for a mortgage. Also, this type of loan is often the best option for borrowers with solid credit scores and is provided by most lenders.
Conventional Loans Requirements
As a borrower, these are the minimum conventional loan requirements you should be prepared to meet:
1. A credit score of at least 620
If you want to take out a jumbo loan, the requirement will be higher: usually at least 680.
2. A debt-to-income ratio limit of 45%
No more than 45% of your monthly gross pay should go toward debt payments. However, some lenders may allow up to 50% if you make a sizeable down payment.
3. Proof of income
Usually, you will need to provide two years of documentation( tax returns, W-2 forms, or recent pay stubs) to show that you have a steady income to afford the loan payments.
4. A down payment of at least 3%
You must submit bank and other asset statements to show how you’ll make your down payment.
Conventional Loans Rates
Rates on conventional loans depend on the term you want to get it.
Image source: usbank.com
Pluses of Conventional Loan
1. Competitive interest rates.
Mortgage rates hit record lows during the coronavirus pandemic. “I never thought I would see conventional mortgage rates below 3% in my lifetime,” Wilk says. “We could look back and see this was a once-in-a-lifetime opportunity.” Then, of course, rates have started to rise again, but they are still relatively low.
2. Low down payments.
You can get a conventional loan with as little as a 3% down payment, Ragusa says. “A lot of people think it has to be 20%, but it doesn’t,” he says.
3. PMI premiums can eventually be canceled.
Once you’ve paid down 78% of your home’s appraised value, your loan servicer will remove your PMI.
4. You can choose between fixed or adjustable interest rates.
A fixed-rate 30-year mortgage is the most common, whether you want to get a conventional or government-backed loan. The main advantage is that a fixed rate can lock in today’s historic low-interest rates, but adjustable-rate mortgages are also worth considering if you’re not planning to keep your mortgage for more than a few years.
5. Conventional loans are used for all types of properties.
Conventional loans can be used for a primary residence, vacation home, or rental property, unlike government-backed loans, which are limited to principal residences.
Minuses of Conventional Loan
1. Stricter credit score requirements than in hard money lenders.
Conventional loans often require at least 620 credit scores, leaving out some homebuyers. Moreover, even if you qualify, you will likely pay a higher interest rate than if you had good credit.
2. Stricter DTI requirements.
Conventional loans usually demand higher DTIs than government programs. Thus, you should expect to meet a standard of no more than 45% DTI.
3. PMI premiums with a low down payment.
Thus, you’ll still have to pay PMI if you put down less than 20%.
Conventional Loans vs Hard Money Loans – What Suits You?
When we talk about hard money loan vs conventional loan, the right option for you will depend on several factors. For example, if you have been turned down for a conventional loan, then hard money may be the solution to helping you get your project funded. Similarly, if traditional lenders’ less flexible loan structures don’t work for you, you may want to explore your hard money options.
Ultimately, the correct loan type will depend on your circumstances and priorities. After weighing the pros and cons of hard money to conventional loan, it’s up to you to consider which loan will give you the flexibility and terms you need to get your project off the ground.
Please always consult with a reputable advisor on what type of loan you should get, or just simply message us on FB, IG, or WhatsApp, or call 323-448-3956.