Real estate investors typically use loans to make their property purchases, whether that be for a fix and flip property, rental property or buy and hold strategy. In this article, we compare hard money vs soft money loans to help you figure out which would be best for you.
Real estate investing is a tried and tested method for making money, however most people cannot afford to invest in property without a little financial help. This is where loans come in. You might be wondering which loan type is best for you, and the decision can be tough. So, we’ll outline the difference between two of the most popular loan types for real estate investors, hard money vs soft money loans.
What is the difference between hard money and soft money loans?
Soft money loans and hard money loans share some similarities in that both require applicants to qualify for the loan based on specific criteria, and both require that borrowers pay back the loan over a certain period of time in line with the repayment terms. Where hard money loans and soft money loans differ is largely around credit score.
Soft money loans take your credit score into account when you’re applying, and hard money loans place less importance on this. Soft money loans use your credit score as part of your eligibility criteria and typically require a higher credit score, and then your assets are used as collateral as well. Whereas hard money loans are given based on the property itself and whether it’s going to be a good investment, instead of placing as much emphasis on the borrower’s personal circumstances. As such, hard money loans are generally issued quicker than soft money loans.
Overview of hard money loans
A hard money loan is a short-term bridge loan that is typically used by real estate investors. Hard money loans are issued by private lenders, either individuals or companies, and the loans use the asset (in this case property) as collateral.
Hard money loans have less stringent lending criteria than traditional loans, which makes them easier to qualify for, and quicker to get. Hard money lenders use the property itself as a basis on which to decide on loan approval, instead of the borrower’s financial standing.
Hard money loans usually have a higher interest rate (generally around 6-8%), due to the riskier nature of the loans for the lender. They also have a shorter loan term of between 6 and 24 months.
Overview of soft money loans
Soft money loans fall between hard money loans and traditional loans, and they are done through different types of lenders, either certified institutions like banks, or, more recently, private lenders. Soft money loans generally have higher security and lower interest rates, due to the fact that they are based on both the property’s Loan-To-Value (LTV) ratio and the borrower’s credit score.
Soft money loans are longer-term and are often used by real estate investors who need large financing that they can pay back over a longer period. Soft money loans are currently being used as an alternative to hard money loans and conventional loans. A car loan could be considered an example of a soft money loan, and these are generally easier to get approved for.
Hard money vs soft money - Key differences explained
Difference 1: Loan terms
The first difference between these two loan types is the loan terms. Hard money loans are shorter (usually between 6 and 24 months), and soft money loans are long term and be over many years (between 15 and 30 years). Either loan can be used by real estate investors, however the different loan terms are useful for different strategies.
For example, fix and flip investors need fast funding and quick loan terms, which means that hard money loans work well for this purpose.
Difference 2: Interest rates
One of the key differences between hard money loans and soft money loans that you’ll notice right away is the interest rates. While hard money loans have higher interest rates of between 6% and 8%, soft money loans have an interest that is often below average.
The discrepancy between interest rates on each loan is largely due to the loan term differences and loan criteria, a shorter loan term with less approval criteria means that there is more risk for the lender so interest rates are higher on hard money loans and lower on soft money loans which go over a longer period.
Difference 3: Application criteria
Hard money lending offers easier and quicker approval than many other loan types. They don’t base the application criteria on the lender’s personal financial situation as heavily, but instead on the value of the real estate deal. This encompasses the property itself, and the After Repair Value (ARV) which indicate what the property will be worth once it has been improved. This is important for hard money lenders because fix and flip real estate deals are the most common usage for these loans, so the potential profitability of the deal needs to be high so that the loan is more likely to be repaid.
Soft money loans, on the other hand, are taken over a period of a few years (anywhere between 15 and 30), so the loan terms are longer, and the repayment structure is different. Loan applications therefore involve the borrower’s personal financial standing by looking at their credit score, income, and down payment. This also means that soft money loans can take longer to get approval for, with the extra checks that need to be done.
Difference 4: Lenders
Hard money lenders are private lenders, which means that they do not fall under a traditional institutionalized lender. Whereas soft money loans can be offered by private lenders or institutions like banks. Hard money loans are therefore not subject to the same rules as institutionalized lenders like banks, so there is more room for negotiation and adaption to each lender’s unique situation.
Difference 5: Underwriting
Soft money loans require more underwriting than hard money loans because there is more security for the lender, which means more checks into the borrower’s financial history, credit score and the property’s LTV, amongst many other criteria.
Whereas hard money loans have less underwriting to do, and therefore hard money lenders can charge lower underwriting fees and have quicker loan approval times.
Who should use a hard money loan?
Hard money lenders are particularly well suited to real estate investment projects that require fast funding, for a short period of time, and can be paid back in full quickly. The best use case for this is typically fix and flip investors. They will need funds upfront quickly, in order to purchase a property and renovate it, but once they sell the property they should be able to pay back the entire loan. So, fix and flip hard money loans are a good solution for this purpose.
Another example of hard money loan usage for people who aren’t real estate investors, is for those who have found a house to buy, but their current house is still on the market. Hard money loans can be a good way to buy the house, and then pay back the loan once you’ve sold your current one.
Who should use a soft money loan?
Soft money loans are better suited to real estate investor strategies that are longer term and where you are in a position to pay the loan back over many years, such as buying a rental property, or the buy and hold strategy. With the lower interest rates, it makes sense for investors who are going to own a property for a long time to take soft money loans and pay less interest and pay the loan back slowly.
The choice between hard money loans and soft money loans often comes down to the condition of the property. Properties that need work are more likely suited to a hard money loan and properties that are fine as is, are more suited to a soft money loan if they aren’t being sold quickly.
Hard money loans and soft money loans both have their pros and cons, the choice between which to use depends on a few factors such as the real estate investing strategy that you’re using, your personal financial situation and the investment property that you have found. Now that you know the difference between the two, you can make a more informed decision for your own unique needs.