Traditional mortgages are difficult to qualify for, and the application process is time-consuming. Many buyers, especially investors, have no time for a lengthy underwriting process. Unlike traditional mortgages, hard money loans are approved in a matter of days and require no credit check or income verification. As-Is Loans of Aventura, FL provides home loans nationwide that help customers close on properties quickly, save their homes from foreclosure and get cash out for repairs.
What Is the Difference Between Hard Money Loans and Other Home Loans
To fully understand how hard money loans differ from other home loans, it’s helpful to review the key components of a traditional mortgage and then contrast them with the essential features of hard money loans. As the comparison below demonstrates, these products are two very different animals.
Hard money loans make sense when loans must be closed quickly, a homeowner or investor has been caught in a financial bind, or an investor needs a loan that covers the cost of the property and planned renovations.
Below we’ll explore the three key reasons to use a hard money loan in detail. First, let’s review how a traditional loan is structured, so we can fully understand how hard money loans differ.
The Structure of Traditional Mortgages
Traditional mortgages are designed for the purchase of primary residences versus investment properties. Because of this, approvals focus heavily on the borrower’s ability to repay the loan over the long term. The lender still likes to see a down payment but may waive this requirement if the borrower’s credit history and financial situation are exceptionally strong.
Hard money loan approvals focus on property value, so credit history is far less important and may not even be a factor in an approval decision.
Traditional Mortgages Are Written for the Long Term
The long repayment terms of traditional mortgages are one of their key features. 30-year mortgages are average. 15- or 20-year mortgages are much rarer. During the housing crisis in the late 2000s, many traditional mortgage loans were modified to 40-year terms.
Traditional mortgage loans offer extended terms because most customers could not qualify for the loan if the term was shorter. Though some financially strong individuals who intentionally buy properties below their means may qualify for a 15- or 20-year term, most homebuyers want to buy the best home they can afford, which usually means a 30-year term.
In contrast, hard money loans are intended as short-term loans of five years or fewer. During that time period, the borrower typically sells the property or refinances into a long-term loan.
Interest Rates Are Low for Prime Borrowers
Prime borrowers qualify for low interest rates, especially in the economic environment that has persisted since the financial crisis. Lenders are comfortable offering low rates for several reasons. First, lenders conduct extensive due diligence on borrowers. Only borrowers with an extremely low risk of default, as judged by the lender’s scoring models, qualify for the prime rates. Lenders believe that the profits on the low interest rates outweigh the expected number of defaults.
Many borrowers can’t qualify for prime rates. These borrowers may qualify for subprime mortgages, which require a higher interest rate as compensation for the increased risk. In addition, the lender may require a larger down payment.
Interest rates for hard money loans are higher, but it’s important to remember that traditional mortgages are amortized over 30 years. As a result, at the beginning of the loan, the vast majority of the payment goes to interest. It takes over a decade for the proportion of the payment that goes to interest to equal the amount that goes toward the principal. As a result, despite a lower interest rate, a traditional mortgage may cost more in dollar terms than a shorter-term hard money loan.
The Approval Process Is Long
Traditional mortgage lenders scrutinize mortgage applications carefully and have extensive requirements. Lenders are particularly interested in verifying income. They want to ensure the borrower can continue making the payments for years to come, so they consider factors that include how verifiable the income is, the source, and its stability. Since loss of income is a major reason for default, verifying income is very important to traditional lenders.
Lenders also focus heavily on credit history. In fact, they base qualifications and interest rates on rigid credit score tranches. Credit bureaus structure credit scoring models to predict the likelihood of default. These models base scoring on borrowers’ payment histories, any collection accounts or defaults, their credit utilization ratios, and credit disasters, including bankruptcies and foreclosures.
If any defaults show on the credit record, traditional lenders may deny the loan or stipulate repayment of the debt before granting approval. They may also require a certain time period to pass after the default before granting approval.
Traditional Lenders Must Adhere to Outside Standards
Many traditional loans are not serviced by the issuer. Instead, the issuer sells its loans to Fannie Mae or Freddie Mac, quasi-governmental organizations that help free up liquidity for new mortgages by taking them off of loan originators’ books. Lenders must adhere to strict requirements to sell loans to Fannie Mae or Freddie Mac. As a result, lenders are limited in the types of loans they can approve. Requirements of government loan programs that back certain types of mortgages also restrict lenders to certain criteria, including:
- Federal Housing Administration loans
- Veterans Administration loans
- United States Department of Agriculture loans
Nonconforming loans, which are not backed by the government or eligible for purchase by Fannie Mae or Freddie Mac, often have far more stringent underwriting requirements, making them unattainable to all except those with exceptional credit scores and high down payments.
Hard Money loans are approved at the lender’s sole discretion. Because of this, lenders can be flexible and grant approvals as long as they can see doing so is a good risk.
Why Use Hard Money?
When your loan needs fall outside of the standards, time frames, and flexibility of traditional mortgage loans, it’s time to apply for a hard money loan. Here are the three most common reasons why a hard money loan makes sense:
You Need to Close Fast
When you need to close on a property before the competition, traditional mortgages kill your deal. In hot markets, buyers entertain multiple offers simultaneously. Often, a bidder using a hard money loan wins because he or she can gain approval almost right away versus weeks or months.
Hard money loans close so fast because lenders base approvals on the loan-to-value (LTV) ratio. Provided the LTV is low enough, the loan will be approved. When you need to close fast to snap up a property, use a hard money loan to secure the purchase. You can refinance into a long-term loan at a later date or sell the property a few years down the line, depending on your needs.
Quick approvals are especially important when purchasing investment properties, including commercial real estate, such as multifamily apartment buildings or industrial properties. Competition is fierce in most locations, and fast approval means you take control of properties with excellent cap rates.
Credit History or Income Verification Disqualifies You from a Traditional Mortgage
Hard money lenders base qualifications on the LTV ratio, not credit scores and income checks. As a result, most do not even pull credit bureaus, so a low score, prior defaults, and even a recent bankruptcy or foreclosure are not disqualifying factors. Hard money loans are the perfect way to buy a new home with bad credit, so long as you have a sufficient down payment.
Distressed homeowners also benefit from hard money loans. For example, if your current lender is threatening foreclosure, you can save your home and its equity by obtaining a hard money loan. Provided sufficient equity exists in the property, you can refinance away from the foreclosing lender and keep the home with a hard money loan, even if in the final stages of foreclosure or bankruptcy.
You Need Cash for a Fix-and-Flip Investment Opportunity
When a strong opportunity for a fix-and-flip investment property comes on the market, investors flock to it and bid aggressively. Waiting weeks or months for a traditional lender isn’t an option, unless you want the watch the competition walk away with your investment opportunity. In addition to fast approvals, hard money loans can also provide cash for repairs.
When hard money lenders consider LTV, they base it on the repaired value of a fix-and-flip investment. For example, if a hard money lender’s maximum LTV is 80%, the investor can take a loan of up to 70% of the value after repairs. If the property costs $120,000 and the repaired value is $200,000, then the investor can borrow $160,000, leaving $40,000 leftover for renovations.
Hard Money Loans Offer Unparalleled Flexibility
Traditional lenders suffer from an underwriting straitjacket and bureaucratic delays. Hard money loans, on the other hand, provide extreme flexibility. Because loans are based on the property’s value, hard money lenders are free to look beyond credit and focus on whether the loan presents a good business deal. This allows hard money lenders to provide loans to buyers in a hurry, distressed homeowners, and fix-and-flip investors.
As-Is Loans works with borrowers no matter their situation. Hard money investors are ready to offer funds based on flexible standards. If you are in need of a hard money or no doc mortgage, call As-Is Loans to qualify today.