Hard Money Lender vs Private Lender: Differences and Similarities Explained
The terms “hard money lender” and “private lender” are used interchangeably in the real estate investment arena. There was a time when these terms were distinct to the industry and the public.
Private lenders were individuals lending money to family and friends without much structure and fees. Hard money lenders were structured and licensed companies to lend money along with fees and higher interest rates.
In today’s market, these distinctions have blurred, and the differences seem subtle. This article will identify the distinctions between hard money and private money and describe the investors seeking these loans for their short-term financing solutions.
KEY TAKEAWAYS
- “Hard money” is the unfortunate disconnect in terminology.
- The differences could be seamless to investors but distinct within the private lending industry.
- Hard money lenders substantially use the value of the “hard” real estate asset to determine the loan terms, while private lenders take a holistic approach with various criteria (i.e. borrower and property) to assess the borrower’s creditworthiness.
- Though they are somewhat different, hard money and private lenders also share advantages and disadvantages.
- A change in web search variables will lead to the right lender for a real estate investment transaction.
Real estate investors know that a conventional lender will not collateralize properties until the value is created and the cash flow is stabilized. However, investors seek properties with a value-add component to create value.
When the property operations become sustaining, the investor either sells the property to fund the next investment or holds the property for income.
In either objective, the investor needs creative financing until the property qualifies for a conventional loan or for a position in the market to sell at its optimum price.
What is a Hard Money Lender?
As briefly mentioned above, a hard money lender places far more emphasis on the asset and the feasibility of value creation than on the borrower profile in the underwriting process in determining the loan amount and interest rate, thus dubbed as an asset-based real estate loan.
The hard money lender gained this designation over time by the types of loans it was willing to fund. The lenders were comfortable extending “money” to loans that were “hard” to place by conventional standards.
Unfortunately, this needed service to the real estate investment sector has become synonymous with predatory lending, like fast cash and payday loans. Due to this negative connotation associated with hard money in the general public’s mind, an industry-wide movement is underway to phase out the use of the “hard money” label.
Of course, this will take time, especially because there are established lenders with “hard money” as their brand and within their marketing plans.
The ability to flex the entrepreneurial muscle comes from not being tethered to federal regulations of pre-set ratios, borrower qualifications, and stable operations.
Since the financial crisis of 2008, loan programs that are creative and flexible are what keep investors bullish on value-add opportunities. This continues today.
What is a Private Lender?
The term “private lender” was widely reserved for an individual, or a private company, extending loans to real estate investors by non-traditional lending criteria.
Then, an opportunity was created as private lending has become a more important pillar of the real estate industry. The private-label mortgage market has transformed over the last 5 years with the introduction of more sophisticated capital markets and technology.
Projected to continuously increase in volume, private lending fills the void left by traditional, large banks. This does not mean that private lending bears the increased risk. Loans made by private lenders are secured by real estate and underwritten with the value of the assets and the borrower profile in mind.
Well-capitalized institutional investors (i.e. private equity firms, pension funds, and insurance companies) have been infusing plentiful capital in search of high-yield yet safe investments, setting the stage for robust liquidity, rigorous guidelines, and competitive pricing.
Thanks to more abundant Wall Street capital infused into the industry, private lenders have been institutionalized and grown into more established organizations over time.
As mentioned above, private lending used to be predominantly capitalized by individual private investors. However, the majority of investment property mortgages today are ultimately funded by varied institutional capitals.
As the capital market has evolved and become more sophisticated, even a secondary market for investment-purpose private mortgages emerged, increasing available liquidity and thus driving down interest rates considerably over the past decade.
Employing more rigorous underwriting guidelines, private lenders evaluate not just the marketability of the real estate collateral but also the borrower’s liquidity, experience, and credit score as a whole loan package.
The underlying collateral must be non-owner-occupied investment properties as lending on owner-occupied homes could pose a threat of heightened government regulations and risk of litigation.
Top 3 Advantages of Using Hard Money and Private Lenders
1. Fast Approval and Funding
Speed is the name of the game in private real estate lending and this is arguably the biggest advantage by far. With the closing in just a week or two, real estate investors can get access to the needful funds very quickly and thus increase the odds of acquiring the subject property timely.
2. Less Paperwork and Fewer Requirements
These lenders are not bound by as stringent rules and regulations as are imposed on banks. Therefore, there are relatively less paperwork and fewer requirements than a traditional loan, which means a higher likelihood of loan approval. Most notably, loans are not subject to the debt-to-income ratio typically imposed on the conventional loan side. In other words, the sky is the limit when it comes to financing as long as each deal makes sense.
3. Flexibility
Hard money and private lenders offer loan products that cannot be financed elsewhere. For example, banks are reluctant to provide financing on properties that need renovating due to rules and regulations. Loan terms also can be more flexible and sometimes negotiated based on the borrower’s credentials and circumstances.
Top 3 Disadvantages of Using Hard Money and Private Lenders
1. Higher Interest Rates and Fees
Due to the increased risk for the lender and the easy access to capital for the borrower, lenders will always charge higher interest rates, possibly along with higher fees, than a traditional bank.
2. Non-Owner-Occupied Properties Only
These types of lenders don’t provide financing for owner-occupied residences due to credit rules and regulations; that is, the investment-purpose loans.
3. Short Payback Period
Most loans are underwritten for 6 to 12 months with an extension up to 24 months. Therefore, the borrower needs to have a viable replacement or exit option in place.
How are the Definitions Blurred?
Both types of lenders are typically funded with private capital and are not subject to federal guidelines in lending rates, requirements, and ratios. The distinctions are defined within the lending industry but are seamless to the public and to the investor needing creative, quick-close financing for their value-add projects.
Since the financial crisis, hard money and private lenders have earned their needed place in the investment market. Hard-money lenders have built their brand and have earned their reputation for lower risk tolerance and entrepreneurial flair.
However, some new lenders came into the real estate private lending industry but do not wish to be associated with the undesirable connotations of “hard money” to predatory lending.
These lenders may be “hard money” lenders by definition but not by brand. And it seems like hard money lenders tend to become more of retail lenders and private lenders more of institutional lenders.
Conclusion
Unfortunately, the disconnect in terminology could lead to missed opportunities for investors to find the right lender for their next deal. A search for “hard money lenders” will exclude the private lenders without the “hard money” designation in their brand. These excluded lenders target the investment in value-add transactions on a short-term basis.
The search terms like “bridge,” “rehab,” “fix-and-flip,” and “value-add,” along with the property type, will give better results in a lender search for investment properties.
In the end, the real and the perceived definitions within the private lending sector are not important. What is important is an investor finding the right loan program for the deal.
Private lenders are not the same. Each lender will offer different loan programs with an independent tolerance for risk. At the end of the day, a loan must be right for the lender’s risk appetite, for the borrower’s investment goal, and for the collateralized asset’s unique characteristics.
