Every type of loan comes with its advantages and disadvantages. It is extremely important as a real estate investor to understand the different types of financing that are available so you can get the best loans to maximize your success.
There are more options than being limited to hard money vs soft money but to keep this as easy to understand as possible, we will focus on putting every loan into one of these two categories.
There is no Webster definition for either of these terms. These are terms you will hear in the real estate investor community but they can have different meanings with different investors. To me, hard money is private money from a well-funded and well-educated investor. There is a tremendous upside to hard money which we will be discussing. Many people define hard money as being expensive and much easier to qualify for. But you’ll find there is much more to it.
Soft money typically refers to the loan pricing. If rates and fees are closer to the market rates and fees, we would put those into this category. This would include banks and conventional lenders. These are commonly more challenging to qualify for but are much cheaper.
Source Of Funding
This will be the biggest distinction between the two. Hard money lenders are almost always privately capitalized, meaning they have investors behind them. Having investors backing the loans creates tremendous flexibility. You will not have the high regulations traditional lenders will have so the hard money lender can approve difficult loans. Private investors expect a higher return, however. This is what drives up the price for hard money loans.
Soft money is capitalized by institutions, FDIC insured deposits, and the government. Banks can borrow money whenever they need it. There are some restrictions on what they can borrow from the government but not many. There is virtually unlimited cash in this space at really low-interest rates.
Hard money loans tend to be a higher risk which means the investors behind the loans want a higher return. It is not uncommon to see rates from 12% to 15% with hard money loans.
Soft money is based on the going rate for that specific loan. It is very competitive for qualified borrowers so rates will be much lower.
Terms Of Loan
Hard money lenders make the majority of their money from fees charged to the borrower. A large chunk of the interest is used to pay investors. For this reason, hard money is short term. It benefits the lender to get paid back quickly so they can loan the money out again.
Soft money terms are more what you would expect. 30-year loans with fixed interest rates. If you go to an alternative soft money lender, like a bank that holds their own loans, rates will be slightly higher, and they will have shorter terms but even those terms are much longer than you will find with hard money.
|Hard Money||Soft Money|
|Ease of Application||Easier approval||Difficult to get approved|
|Term||Short term||Long term|
|Cost||Higher cost||Lower cost|
|Loan Approval||Has more flexibility and low down payments||Has a strict set of rules and restrictions|
|Properties||Any condition||Must be habitable|
|Paperwork||Less paperwork required||A high amount of paperwork|
|Closing||Very fast, sometimes just days||30-45 days is common|
The Pros & Cons
It is important to know the pros and cons of each to make the best financing decision for your next real estate investment.
Hard money is a very specialized loan for real estate investors. It is most commonly used for short-term needs such as a fix and flip. It can also be used if a house is in rough shape and does not qualify for soft money or if the investor needs to close fast. It is also much higher leverage so investors can buy a property with little or no money down.
Soft money is far more common. It is great because they have favorable terms, such as 30 year fixed rates. Rates and fees are much lower too.
The biggest con to hard money is the price. High fees and high rates can make it unattractive to uneducated investors. Hard money is only a tool real estate investors can choose to use or not. It is not the best fit in every situation but it is the perfect fit in certain situations. Be sure to call your hard money lender to understand the loan and then only use it when it will increase your profits or help you accomplish your goal.
The biggest con for soft money is the qualifying. There is a tremendous amount of red tape and if you don’t fit into the box, you won’t get the loan. It is also meant for longer-term loans so it could cause problems for your lender if you are doing a fix and flip and pay the loan off within a year.
The Best Suited Loan For You
The type of loan that will be best for you will depend on what you are trying to accomplish. Even inside the world of hard money or soft money, there are multiple options. As you navigate your financing options as a real estate investor, you will get more and more comfortable with the different types of loans and the different terms being used.
I always recommend that you talk to a professional to dig into your specific situation and it is best to find a professional from a referral from someone you know or someone with positive reviews online. I love going to real estate networking events to get to know other investors. If they are successful, I always ask. “How do you finance your deals?”