Suppose you want to successfully fix a property without interest rates and holding costs eating into your profit. In that case, you need a financing option that’s as time-sensitive and flexible as your project. After all, your choice could make or break your deal, and that’s why savvy real estate investors don’t rely solely on one source of funding. Choosing between hard money vs soft money loans can impact the potential profit and timeline of your fix-and-flip project. Ideally, your choice should align with your investment goals and current situation, so we’ve put together this article to help you decide which works best for your next flip.
What is a Hard Money Loan?
A hard money loan is a short-term loan secured by the property the investor plans to purchase. In other words, unlike traditional bank loans that often require no collateral, hard money loans are asset-based loans where the borrower agrees to forfeit the new property if they default on their loan. However, such instances are rare, and investors are often able to secure funds much quicker than with a conventional mortgage, to complete their project and meet the repayment terms.
Pros and Cons
Pros
- Get Fast Approval: If you’re working against the clock, hard money loans are your best bet. Instead of waiting weeks for approval, a hard money lender can approve your request within days. That’s a huge advantage for investors looking to capitalize on opportunities in a highly competitive real estate market.
- Enjoy Flexible Terms: Call the shots on how and when you repay when you opt for a hard money loan. Since these lenders are more open to negotiating, with the right skills and leverage, you can score yourself a better deal. In comparison, conventional and soft money tend to be a lot more rigid, forcing you to agree to terms that don’t necessarily work in your favor.
Cons
- Pay Higher Interest Rates: Pay more for the added convenience of their fast approval rating when you opt for a hard money loan. Despite agreeing to use the prospective property as collateral, this funding option is still high risk in comparison to traditional lenders that vet their borrowers more closely. Hard money lenders tend to charge more in interest, often ranging from 8% – 15%.
- Complete Your Project Within the Short Repayment Period: Aside from potentially paying more for the loan, you also have to complete your fix-and-flip project within a short period to pay it off on time. Otherwise, you have to refinance your loan to avoid defaulting and losing your investment.
Why Do Fix and Flip Investors Prefer to Use Hard Money Loans?
- Faster Acquisition: Hard money loans are the best option for investors who need to close quickly, either because the market is competitive, or you found a great time-bound deal. Since hard money lenders worry more about the property’s value than doing a detailed financial check, you can secure the funds you need in days to move on with your project.
- Financing Based on ARV: Another reason investors fix and flip investors prefer hard money loans is that the lenders assess the property using its after-repair value (ARV). In other words, even if the property is currently in a bad shape, you can still get reasonable funding based on its future value. Thus, hard money loans are especially favorable if you plan to undergo major renovations and don’t have the necessary funds. Of course, there are other expenses in fixer-upper homes that should not be ignored during the renovation phase, including your closing and holding costs, which the extra funds can help cover.
What is a Soft Money Loan?
A soft money loan is a cross between the more popular hard money loan and a conventional loan. Like the former, they are often backed by private lenders and specialized institutions, and like the latter, they emphasize the borrower’s financial qualifications before signing an approval.
Pros and Cons
Pros
- Enjoy Lower Costs: If paying 15% doesn’t sound appealing to you, soft money loans offer investors much lower rates that sometimes rival those of traditional mortgage rates. With the right lender, you can even get rates for half that at 6% interest, hence lowering your overall financing costs.
- Get a Longer Repayment Period: Hard money loans are typically short-term, which can put undue pressure on investors to complete their projects and pay them off on time. On the other hand, soft money lenders offer short to medium-term loans, with repayment periods lasting 6 to 24 months. That gives you more room to repay your loan at half the interest.
Cons
- Prepare for Stricter Borrower Qualifications: Unlike hard money lenders, who care more about your property value than your credit score, soft money loans have stricter borrower qualifications. As a result, they’re much harder to secure if you don’t have a solid financial background.
- Anticipate Slower Approvals: As a ripple effect of having a much stricter borrower qualification that requires background checks, soft money loans also have a slower approval time, often running into weeks.
Why are Soft Money Loans Less Common for Fix and Flip?
Despite being more flexible than traditional loans, soft money loans are less common for fix and flips because their approval timeline is longer than hard money loans. Since investors often have to work under pressure, often seizing opportunities when they see them, they prefer to go for the option that provides quick access to funds.
Importance of Aligning Loan Choice and Investment Goals
Ensure Project Feasibility
For starters, aligning your loan choice with your investment goals ensures that your project goes according to plan. For instance, if you’re planning on flipping a distressed property with lots of structural and cosmetic renovation, a longer timeline and at affordable interest rates may be more suitable for you. Thus, a soft money loan may be the better option, as opposed to the more popular hard money loan.
Improve Financial Planning
Another reason you should consider your goals before choosing a loan is to improve your financial planning. Each loan comes with its own repayment structure, and that ultimately affects how you manage your cash flow to ensure you meet your monthly and balloon payments.
Conclusion
Choosing the best financing option for a real estate project isn’t a one-size-fits-all answer. For most fix-and-flips, hard money loans are the better alternative because of their fast approval rates and habit of using ARV to determine the loan amount. They’re also a great option for borrowers with a murky financial history. On the flip side, soft money loans come out on top if you need a longer repayment period at lower interest rates.
In the long run, every investor has different qualifications, timelines, and investment goals, and it would be best to consider your unique circumstances to make an informed decision.
Recent Comments