What Soft Money and Hard Money refer to is money that is loaned from a lender to a borrower. Usually in real estate investing and other asset type loans.
Usually, the money is used for a specific and intended purpose investing in real estate. So, let us first explore the definitions of what soft money and hard money is in the world of real estate.
What is hard money in real estate?
Hard money in real estate refers to a monetary loan that is used for an individual’s specific needs. It will also generally have criteria that outline how it will be paid back.
These types of loan are essentially asset-based financing, the individual who is borrowing receives money, and the lender or loan providers funds are safely secured by the property.
These types of loans are usually issued by private companies or investors.
What is soft money in real estate?
Soft money in real estate refers to money that is borrowed, however generally there is no specific intention or use.
Soft money combines the method of hard money loans with the traditional and conventional type of loan.
The loan is based upon the borrowers credit score and their ability to repay a loan.
The interest rate is lower than average, and they are usually easier to acquire.
What is the difference between soft money vs hard money?
Essentially the most notable differences between hard money and soft money are that soft money is more appropriate for long-term investments.
Whereas hard money is better equipped for funding short-term investments.
Below we have listed some of the most important and key differences between hard money and soft money.
The general meaning of Soft Money Vs Hard Money
Hard money loans are a type of asset-based financing, thereby the borrower receives money and the funds of the lender are secured by the property in question.
Soft money is a type of loan (issued by a bank) that is usually secured by the collateral of specified real-estate property.
The borrower is contractually obliged to pay the loan back, with interest.
The rates of interest for hard money vs soft money
Interest rates for hard money are typically higher than those of soft money. This is because hard money loans carry a greater risk to the lender.
Borrowers of hard money could expect to pay between 15% to 18%.
Soft money loans will typically have interest rates between 2% to 4%, depending on the length of the contract.
Are there any risks to hard money?
Hard money is considered more risky because it is a short term loan and must be repaid with a balloon payment after the term is over. If payment is not completed the borrower risks default on the loan and the hard money lender will take the property.
Soft money on the other hand, has a much lower risk.
This is because soft money lenders hand out loans based on the credit score of an individual, allowing them to understand and give more of an insight about the individuals financial history.
How easy are they to obtain?
Hard money loans are usually obtained in a shorter amount of time compared to soft money loans. This is because hard money loans are not as heavily regulated and do not require such a large amount of paperwork.
Also credit checks and researching a borrowers financial history could take time for a soft money lender.
Length of investments
Long term loans mainly use soft money, whereas short term loans and goals are more suited for hard money lending.
Rules and Regulations
Soft money loans are generally considered to be more strictly governed and restricted, particularly in the United States.
Hard money is not controlled or restricted by any form of governing body.
Loan Flexibility
Hard money provides much more flexibility in structuring a loan, whereas on the other hand soft money has a very rigid set of rules and restrictions for the structure of the loan.
This is because hard money lenders are less restricted by laws and regulations. If they have a repeat client that is well trusted, they may be able to offer a more flexible procedure by extending the loan time period.
How much paperwork?
Hard money requires much less paperwork when closing a contract on a house or property. Soft money however requires a high amount of paperwork for closing on a property.
What is hard money and soft money lending?
Hard money and soft money lending are forms of borrowing money.
From buyers purchasing land, residential property or commercial property, individuals who do not own the full asking price of the property that they wish to acquire, will usually turn to a form of hard money or soft money loan.
The specific loan that they choose will depend on a number of factors like their credit rating, urgency, and also sometimes the condition of the property that they wish to purchase.
Are hard money loans a good idea?
Hard money loans are generally considered a good idea only when certain factors or situations apply. For example, they are ideal in some of the following circumstances:
- Loans for purchasing and acquiring land.
- Construction loans.
- Purchasing an older property or a property in poor or dilapidated condition.
- When a buyer or borrower has a bad or low credit score and cannot obtain funding through a bank loan.
- When an investor needs to act quickly, as hard money loans can usually be processed more quickly.
What are hard money loan rates?
Generally, hard money interest rates will be higher than the interest rates of soft money. Individuals can usually expect the rate to be between 12% to 15%. On the other hand, soft money rates of interest are considered to be lower, and in some circumstances below average.
The maximum loan amount is typically 90% LTV and 75% ARV, these rates are set by the private lender themselves. The rates are determined by the equity of a property, the amount of risk and also how invested the borrower is in the project or purchase.
Generally the higher the risk is, for example high loan to value ratio, poor property condition, and lack of buyer experience, the higher the overall price of the hard money loan will be.
As these types of loan are handled by private companies and investors, they or not regulated in the same way as conventional loans.
Below we have analyzed some of the factors that can affect hard money loan rates:
- The LTV (Loan to Value)
The LTV ratio can help to determine the risk to a lender. The risk will be lower if the borrower has a larger sum of their own money invested in the purchase.
As an example if a property value is $10,000 and the borrower wishes to borrow $8000, the LTV percentage will be 80%. Generally, with the LTV at 80%, a higher interest rate would be incurred than a rate at 60% LTV. - Exit Strategy
The exit strategy of a hard money loan is important. It essentially determines the amount of time in which a lender will have their money at risk.
An example of an exit strategy is selling the property, refinancing the hard money loan into a conventional loan, or even selling off other investments to help to pay off the hard money loan. - Region Dependent
Depending on the state or region hard money loan rates can vary. Some lenders operate nationwide, whereas others may only cover a small area or region.
The loan rates offered by nationwide lenders will sometimes depend on the area or location that the property resides in. - ARV (After Repair Value)
Some lenders will determine their rates based on the after repair value ARV, which is the estimated value of the property after it has been improved by the borrower.
Do hard money lenders require a down payment?
The majority of hard money lenders can sometimes require a down payment of a certain amount, this can be approximately 10% or higher of LTV (loan to value), or 25% or higher of ARV (after repair value).
The LTV ratio is the amount that is being borrowed, compared to the actual value of the property. The ARV is calculated and estimated on the value of the property, after any work or renovations have been completed, adding to the value of the property.
What are the Pro’s and Con’s of Soft Money Loans?
Soft Money Loan: Pros
Helps with credit history
A great benefit to soft money loans is that they can become a part of an individual’s credit history. This can even help to repair the credit history of an individual.
Flexibility
Soft money loans are much more flexible with the repayment schedule. Although it can often be influenced by the credit rating of the individual borrowing the money.
Lower rates of interest
Soft money loans generally have much lower rates of interest, although this again could be influenced by the credit rating of the borrower. If they are considered a risk the interest rate could be higher.
Soft Money Loans: Cons
Closing times
Soft money lending has a longer closing time, of about ten to fourteen days usually.
Other forms of financial reassurance
On occasion, soft money lenders may require other forms of financial reassurance when lending money. For example a borrower may need to prove that they have at least 3 months’ worth of repayments in reserve.
Bad credit means no approval
Soft money lenders will always check an individual’s credit rating. If they have bad credit, they would be highly unlikely to lend money.
What are the Pro’s and Con’s of Hard Money Loans?
Hard Money Loan: Pros
Quicker process
As only one individual lender or a small group of lenders are being worked with there will be a reduction in the number of hoops and barriers to pass through.
Hard money lenders will not usually take your credit score into account, or take note of how much debt you may possess.
They only take an interest in the value they can see within a property. This is because the property is the actual asset that will be backing the loan itself.
It is much easier and quicker to obtain a hard money loan compared to a soft money loan as hard money lenders are not usually considering your credit history only the value of the property. Depending on the lending provider, it could be with you within a few days or weeks.
The borrowing amount is higher
Banks will usually prefer a down payment of up to twenty percent of the purchase price of the property.
If a borrower puts down a down payment of less than twenty percent, a higher payment will be created as you may need to purchase mortgage insurance.
This minimizes the risk to the lender, as they will be able to claim the remainder of the balance in the event that a borrower is unable to pay.
With hard money loans, a lender may be willing to lend the full amount of the purchase price of the property.
Without needing to provide a down payment the borrower will only therefore be responsible for paying an origination fee and the monthly interest fees until the loan has been fully paid.
Establishing a relationship with the lender
Lenders will often honor and appreciate those who have paid their loan back, earlier or on time.
Therefore any future loans an individual may wish to take may have a slightly reduced origination fee, a quicker processing of receiving the loan, and may even lend a higher amount of the purchase price.
Great for first time buyers or investors
For those just starting out a hard money loan could allow you to purchase property without the individual actually owning a lot of money.
Hard Money Loans: Cons
A high interest rate
Interest rates are generally higher. This is because the amount of money is high and the length of time is short.
As a lender is taking a great risk by lending so much money, a high interest rate provides a very good incentive for an individual to pay the money back more quickly.
Although, if the investor or individual pays the hard money loan quickly or on time the rate of interest will not have a great affect.
A high origination fee
This type of fee is the money which a lender will charge to an individual for processing the loan itself.
As a hard money loan is considered more risky, a high origination fee again helps to protect the lender.
Risk of losing the property
If a loan cannot be paid back, there is the ultimate risk of losing the property. This is because the property itself is the ‘guarantor’ of the loan.
Not a long term option
Hard money loans are in no way similar to soft money loans in the length of time they need to be paid back. A hard money loan will usually need to be paid back within a few months or years.
As time increases there can also be the risk of the interest rate greatly increasing.