The world of real estate investing has become hugely popular in recent years. We see people buying and selling homes and making significant money doing so. A lot of times there are even people in our own lives turning themselves into wealth-building real estate investors. This dream can become a reality, if only we knew how to get started.
Most people’s experience in real estate starts and ends with the purchase of their own homes. They work with a realtor to find their dream home and secure their 30-year mortgage at a low-interest rate after weeks of credit checks, income verification, asset valuation, and more. After months of back and forth and an extensive closing process, they finally get the keys to their new house.
This process works because it’s a safe, low-risk proposition. It utilizes what is called ‘soft money’.
But this is NOT how real estate investors operate. They need access to quick, liquid money that can get them in and out with profits in hand. People making money in real estate today use ‘Hard Money Loans’ to get their deals done.
If you’re new to this world you need to know the difference between hard money and soft money. More importantly, you need to know which one is right for your investment.
Here are a few categories where hard money and soft money differ:
Term of the Loan
‘Term’ refers to the length of time that your loan is contracted for. In theory, the term of a loan can be whatever the borrower and the lender agree to. Conventional lenders prefer longer terms in nice round numbers. You might have an auto loan with a term of 5 years. Maybe you’re a homeowner with a 30-year mortgage. These are all examples of soft money loans.
Hard Money loans have a significantly shorter horizon. Milwaukee Hard Money offers our products with a standard 6-month term. Others in the industry might have their products available with a slightly longer period, but it’s rare that anyone would use a hard money loan for something longer than 2 years. The reason for this is simple; hard money loans are best suited for investment opportunities with high levels of urgency. The borrower needs quick financing to obtain a property and make the necessary improvements. In a very short period they buy, improve, and profit on the sale of their property able to repay the full amount of the loan at the end of the term.
Oftentimes, after the improvements to the property have been made, investors will seek to refinance with long-term soft money. This allows them to pay back their hard money obligations, realize the profit in their investment, and continue to grow their wealth through rent payments or property appreciation.
There is no correct term length. It’s all about finding the specifics that meet the needs of your deal.
One of the biggest differences between hard money and soft money is the use of credit reporting. In a perfect world, lenders would know exactly who is going to pay back their loans and who isn’t. The best real-world approximation of this is accomplished by running a credit check on the borrower. But these credit checks take time and effort.
For soft money lending, that’s okay. The term of the loan is typically longer and there’s not as much urgency to get the deal done. Conventional lenders run credit checks and have strict standards for who will receive their money. From their perspective, they want their loans to be as safe as possible because their revenue stream relies on consistent payments over a long period.
Hard money is different. Yes, companies like Milwaukee Hard Money want and need our clients to pay us back. That said, we also recognize that some opportunities can’t wait for lengthy credit reporting, income verification, and all of the other steps that banks might take before finalizing a loan. We also know that not everyone has a perfect credit history. Hard money loans are inherently riskier for both lender and borrower, but they also have more upside potential.
If you have a mortgage, you’re likely to pay an annual interest rate between 3.13 % and 7.84% (2021). With interest rates at near-record lows, you might be paying even less. These rates are an indication of soft money. And the reason why they’re able to offer such low rates is that they have long terms and perform extensive due diligence before initiating the loan. They profit by collecting smaller interest payments over a long time. In many soft money cases, there is a penalty if you pay off your debt before the end of the term exactly because they need those longer-term payments.
Hard money typically comes with significantly higher interest rates. Milwaukee Hard Money offers our products at a non-negotiable rate of 15%. We’re able to do this because we accept a higher degree of risk (no credit checks) and can meet our clients’ urgency. Hard money loans are often secured by the real estate asset itself and valued against the after repair value (ARV) of the property. Customers can accept these rates because they know they know the resale (or refinance) of their property will give them a wide margin.
All told, there is no ‘best’ option for securing financing. There is only the right option for your particular investment. Hard Money and Soft Money both have instances where they prove to be the correct choice. If you have questions about which structure makes the most sense for your investment opportunity, reach out to us. We’ll have an honest, up-front conversation and provide you with the right loan for your needs.