How Are Hard Money Lenders Different From A Bank?

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Hard money loans, also known as asset-based loans, got their name because lenders base their decision to approve a loan or not mostly on the property’s value. Since it relies on a hard asset, we call this loan a hard money loan. These loans usually come from private lenders, whether it’s a company, a group of investors, or an individual. Most commonly, their purpose is usually business rather than home or personal improvement. The borrowers usually ask for loans for commercial and investment properties, such as rentals or house flip-flops. 

In many ways, hard money loans are similar to bank loans. At first sight, it’s the same process: you apply, they approve and then fund your loan. However, the difference between the two is in the details. 

Let’s go through the main differences between a hard money loan and a traditional loan:

Terms and Purposes 

There are distinctive differences in loan terms because of the different purposes of each loan. 

Banks offer mortgages assuming that the owner will occupy the property in question for a long time. As a result, the repayment time for conventional mortgages usually goes up to 20-30 years. It helps keep the payments low so the borrower can maintain their quality of life, but it also builds up interest over so many years. 

On the other hand, hard money loans are best for investment properties that the borrower is going to sell after fixing or use as a rental business. Because they’re best for business transactions, the repayment time of hard money loans is significantly shorter than that of a bank loan. Usually, it’s over six months to two years. Hard money is suitable for investors because the terms give them the ability to move quickly and close deals, but it also gives them enough repayment time to generate revenue. 

Application

There are significant differences in the application process between these two loans. Applying for a hard money loan includes far less documentation compared to conventional loans. Moreover, the documents a hard money lender asks for are different than those a bank requires when approving a loan. 

The primary concern of every traditional lender is your creditworthiness. It is the primary factor on which they base their decision to approve or deny you the loan. The bank will want to know if you have enough regular income to be able to repay what they’ve borrowed you. Moreover, banks will want to see a clean credit report before they decide to approve your loan. The average credit score required for mortgage approval in the United States is 685. Banks also determine your DTI ratio, which they calculate by dividing your debt payments by your monthly income. For a bank to consider approving a mortgage, your DTI needs to be below 45%. 

Hard money lenders will focus on different documents and different assets. Primarily, they will want to know about the property value and if it can cover the loan. The lender will ask for a property appraisal and the expected ARV (after-repair-value) on the estate you plan on purchasing. Let’s say you want to buy a $60,000 property, invest in repairs, and then sell it for $100,000. The LTV ratio is 60% in these cases, and hard money lenders prefer the ARV ratio to be under 70%. However, they need at least 30% to consider the loan a good investment. 

The soundness of your investment and its after-repair value is an essential aspect for every hard money lender when it comes to approving a loan. However, it doesn’t mean they still won’t check your credit score and income. It only means they will base the final decision on asset value rather than on your creditworthiness. 

Approval and Funding

Probably the most significant difference between bank loans and private money loans is the speed of loan approval. Typically, hard money loans take significantly less time to go through the application process and get approved much quicker than traditional loans. Whereas you’ll usually wait around 30 days for a bank to approve a loan, hard money lenders typically approve it within a week or so. 

While waiting for 30 days may not be such a big deal for, say, a person looking for a loan to improve or renovate their home, it’s a tremendous deal for real estate investors looking to buy an estate. Most sellers won’t wait for an entire month before they see the cash, so being quick is a high priority for investors. Time is of the essence in these situations which is why hard money loans work best for investors. Some private lenders will approve your loan and fund it, all within several business days. 

While they may seem similar, bank loans and hard money loans serve different purposes and propose other terms. Traditional loans are convenient if you need an extended repayment time with small payments. However, if you’re looking for a quick loan to close a significant investment, a hard money loan may be a better choice. 

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