Real estate is a lucrative business. But you need a considerable amount of capital. If you do not have adequate funds up front, you will need to think about alternative sources of financing. Consider the following two options:
- Conventional Mortgages
- Hard Money Loans
Before you can make a decision, you need to understand the difference between both of them.
Financing Sources
First, we need to clarify the term conventional mortgage. Contrary to how the term is usually used, conventional mortgages involve financing typically done through a small, local/regional bank. These loans tend to remain in the portfolio of the lender that underwrites them. Meaning they are not sold on the open market like traditional mortgage loans. Conventional loans typically have terms of 15 – 20 years, with an adjustable interest rate built into the loan. Moreover, the rate can be adjusted every 3 – 5 years, depending on the bank’s tolerance for interest rate risk.
A traditional mortgage loan is also referred to as a conforming loan because it conforms or complies with Fannie Mae or Freddie Mac underwriting guidelines. They typically have 30-year terms and offer the lowest market rates available. These types of loans are sold on the open market, many of which end up as some form of a bond fund. Most of the rates for these are fixed for the term of the loan.
On the other hand, hard money loans are short-term loans funded by private investors. The loan may come from individuals or a group of investors who are willing to lend money using the property that you are investing in as collateral. The interest rate is much higher, and the term of the loan is always shorter. A 12-month term is common, though some can be shorter or longer.
Leverage
The most important benefit of using hard money financing is that it allows you to use leverage. This means you can borrow more money from the lender and bring less of your own money for the purchase. Hard money lenders typically loan up to 70% of the after repair value. This percentage is referred to as loan-to-value. These loan-to-values can go as high as 75% in some situations as well. A typical conventional or conforming lender will require 20% of the purchase price as a down payment, while a hard money loan can have zero out of pocket costs at closing.
Closing Time Frame
There is a notable difference between the speed and time with which a deal can be reached. In fact, it’s one of the most significant aspects of acquiring real estate property. If you cannot obtain appropriate finances within an allotted time, you could miss out on opportunities, especially in hot markets with multiple offers. A conventional conforming mortgage product can take up to 30 days to close the transaction. But with hard money loans, you can expect to close within a week or even less.
Interest Rate
Hard money lenders Houston are available for a reason- to provide short term finance options to real estate investors who wish to rehab and flip properties as quickly as possible. Since the majority of them are distressed, there is a greater risk involved. And because of the convenience and ease of procuring a hard money loan, HMLs tend to charge a higher interest rate. After all, they are in business to make a profit as well.
Property Type
Banks or credit unions that offer conventional loans facilitate homeowners in purchasing a residential property, either for renting or personal use. The criteria are based on the credit-worthiness of the borrower and the condition of the underlying asset. Conversely, hard money loans target distressed properties, whether it’s residential or commercial. But because of the high-interest rate, it’s not a suitable choice for individuals planning on buying a personal residence. HMLs are best for investors looking for ways to make a few quick bucks. They can either flip the property or refinance it and keep it as a rental.
Conclusion
Here’s the bottom line. If you’re planning to invest in a house by paying a low-interest rate for a few decades, then, by all means, head on down to the nearest bank or credit union.
However, if you’re in a hurry to close a great deal and don’t want to get entangled in the red tape involved with conventional loans, HML is an easy way out. Just be careful and read the fine print. Pay close attention to the terms, interest rate, and any additional fees. Make sure you have a quick exit strategy to make the most profit.
