Hard Money vs Soft Money Loans in Real Estate

Your specific goals and circumstances will help you determine whether you’d do better with a hard money vs soft money loan.  In this article, we will describe the differences and similarities between the two, and then address which one is best for you.

Hard Money vs Soft Money Loans

Hard money loans are a type of asset-based debt secured by real estate.  Soft money loans are similar, except they depend on the borrower’s creditworthiness more than hard money loans do.  Let’s take a closer look at their similarities and differences.

Hard Money vs Soft Money: Similarities

Both hard money lenders and soft money lenders are certified lending institutions that issue loans for buying and rehabbing real estate properties.  Here are some factors both types of loans share:

  • Purpose: You use these types of loans to buy or renovate real estate, including investment properties.
  • Borrower History: Both types of lenders investigate borrower history and factor it into their decisions.
  • Terms: Typically, both types of loans require collateral and/or a down payment.
  • Payments: Typically, both require monthly interest payments over the term of the loan.  Hard-money loans are often interest-only.

Hard Money vs Soft Money: Differences

To begin, borrowers typically use soft money to finance long-term projects, whereas hard money typically finances shorter investments.  Check out this handy chart for a summary of differences when considering hard money vs soft money:

 

Contrast Chart: Hard Money vs Soft Money

CharacteristicSoft MoneyHard Money
SourceBanks and private lendersPrivate hard money lenders
TermLong-term loanShort-term loan
UnderwritingCredit score; ability to make paymentsAfter-repair value
Property ConditionGood conditionPoor condition
Closing60-90 DaysAs fast as five (5) days
Interest RatesLower interest ratesHigher interest rates
Owner-OccupiedUsually, noSometimes
FlexibilityHighly standardized loan structuresMore flexible structures
Government RegulationMoreLess
PaperworkMore procedures and paperworkLess paperwork
Interest Only LoansUsually, noFrequently, yes

 

As you can see, hard money lenders are sensitive to the after-repair value of the property.  Whereas soft money lenders are primarily interested in the borrower’s ability to service the loan.  For rehabs, soft-money lenders consider the value of the property as it currently stands.  Whereas hard money lenders give you credit for the after-repair value of the property.  Thus, soft-money lenders can base loans on the property’s loan-to-cost ratio, while hard money loans can depend on the loan-to-value ratio.

Which Is Best for Me?

To know whether you’d be better off with hard-money vs soft money financing, you should consider your creditworthiness and the type of property you are financing.  Therefore, to select the better choice for your individual situation, consider the factors that follow.

Equity Contribution

Some hard money lenders may require you to put up as much as 40% of the after-repair value (i.e., 60% LTV).  Soft money lenders typically require the borrower’s equity contribution of at least 20% of the property’s LTC, though some deals require as little as 10%.  Thus, your ability to contribute equity to the real estate investment might determine which type of loan you can obtain. 

Hard money loans are asset based and secured by real property

Fix and Flip

When comes to hard money vs soft money, a hard money loan is more appropriate when you plan to quickly and extensively redevelop or rehabilitate an existing property such that you substantially increase its value.  That’s because hard money lenders use the after-repair LTV to calculate the loan amount.  And, the short-term nature of the project fits the characteristics of a hard-money loan. 

For example, suppose you purchase an office building at $10 million.  You also have a plan to rehab it such that its value would increase to $15 million.  A hard money loan would provide you 60% of $15 million, or $9 million in financing.  Whereas, a soft money loan on the same property might yield financing up to 80% of $10 million, or $8 million.  In other words, a soft money loan would produce an extra $1 million in funding compared to a hard money loan.

Buy and Hold

If your plan is to acquire a long-term investment in real estate, a soft money loan will serve you best.  Typically, you would achieve this investment by purchasing a property, making minimal changes to it, and then leasing out the space.  This would establish a source of long-term income.  This scenario benefits from the lower interest rates that soft money provides.  In turn, you’ll pay less over the long haul.

Credit Score

If your credit score is below 640, you should most assuredly concentrate on obtaining a hard money loan.  Because, in hard money, your creditworthiness is less of an issue.  By limiting the LTV to 60%, hard money lenders protect themselves from borrowers who end up defaulting on the loan.  If and when a hard money loan default occurs, the lender can seize the property and sell it as is.  Or, the lender can complete the rehab and then sell it.  On the other hand, if you have a good or excellent credit score, a soft money loan will let you leverage your score with the loan committee.

Reserve Funds

Another consideration for hard money vs soft money financing is your ability to reserve at least six months of payments.  If you can do so, you can help overcome objections that hard money lenders might have about your ability to meet your obligations.  Since, by definition, you probably have a low credit score.  Soft money lenders will also appreciate a six-month reserve if your credit score is only fair.

The Need for Speed

It’s good to note, you can obtain a hard money loan in as short as ten (10) days.  Whereas, in a soft money loan, you’ll need a month or more to secure and fund the soft money loan.  In many situations, an investor has only a short period in which to acquire a property.  This is especially true in a fix-and-flip situation, because investors purchase many such properties at public auction following foreclosure.  In an auction environment, it is important for you to have fast funding or else you might lose an otherwise winning bid.  On the other hand, if your investment is not time sensitive, a soft money loan might be the better choice.

Assets America® Funds Hard Money and Soft Money Loans

Wherever you fall within the hard money vs soft money decision, Assets America® offers an extensive network of banks and private funding sources who can close on the funding you need.  Contact us today for more information at (206) 622-3000 or info@AssetsAmerica.com.

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