Two of the biggest knocks on hard money lending are shorter terms and higher interest rates. Terms can be as short as 6 months while interest rates can be several percentage points higher compared to traditional financing. But are shorter terms and higher interest rates so bad? Not necessarily. When compared to what borrowers get out of hard money, they may not be bad at all.
Shorter Loan Terms
Actium Lending is a Utah hard money firm based in Salt Lake City. They say that hard money loans rarely have terms exceeding 36 months. Terms of 6-24 months are the norm. The shorter the terms, the more amenable lenders tend to be.
To a consumer attempting to purchase a suburban home, a 24-month term would be absurd for a mortgage. Most buyers would not be able to afford the monthly installments. But things are different in real estate investing.
Investors are not necessarily turned off by short terms. For starters, most of them use hard money loans for initial acquisition because borrowing criteria is less stringent, and lenders can work much more quickly. They can turn around later and refinance through a traditional lender.
There is something else to consider: investors with sizable portfolios are less worried about repayment. They have the resources to handle it. They would rather not tie up their money in a long-term relationship with a bank. They would rather get in and out of a hard money loan in 6-12 months.
The Interest Rate Issue
Financial experts hoping to dissuade borrowers from considering hard money tend to focus a lot on interest rates. They have no trouble reminding their readers that interest rates can be several percentage points higher on hard money. But again, that might not be so bad.
The first thing to note is that time is the real enemy where interest is concerned. The amount of money consumers pay in interest on a 30-year mortgage is astronomical. Why? Because interest is calculated annually as a percentage of the outstanding balance. It is not a onetime calculation. The longer it takes to pay off a loan, the more total interest the borrower pays.
Short loan terms are a hard money borrower’s friend because they limit the total amount of interest paid. A $100K loan with a 6-month term and a 12% interest rate will generate interest payments of just over $3,500. Yet a 30-year loan on that same amount of money at 6% will generate interest payments in excess of $115k. It is all about time.
What Borrowers Get in Return
Yes, shorter terms can put the pressure on. Interest rates on hard money loans would be more attractive if they were in line with their traditional counterparts. But borrowers are willing to accept short terms and higher rates because they get so much in return.
For starters, they get fast access to cash. Lenders like Actium Lending can approve and fund loans in days. Traditional lenders take months to approve and fund. Hard money lenders require very little documentation. Traditional lenders require tons of documents. Finally, hard money is asset-based while traditional lending is based on the perceived ability of the borrower to repay.
Hard money lending gets a bad rap due to short terms and higher interest rates. But it’s an undeserved bad rap. When you really stop and analyze how hard money lending works, the shorter terms and higher interest rates are not so bad after all. They are well worth it compared to what borrowers get in return. That’s why the hard money industry thrives.
