Finding the right financing option when purchasing a real estate property can often come with some hurdles. While traditional mortgages and private lending are similar in essence, they have different lending rules. Most people are familiar with a traditional mortgage, which means they’re also no stranger to the stringent rules attached to it. With private lending as an effective alternative for an investment project, it’s no surprise that it’s gaining traction.
This post will help you understand the 4 big differences in traditional mortgages and private lending.
Traditional Mortgage Loans
A traditional mortgage is a long-term loan issued by banks or credit unions to finance a real estate purchase. However, you have to meet strict credit and income requirements. A traditional mortgage, which you can get at a fixed or adjustable rate, often requires 10-20% down payment of the total home value. On the other hand, if you’re allowed to put down a 5% down payment, you’ll be required to pay a mortgage insurance premium until your equity reaches 10-20%. Because of this premium, you’ll probably be adding to your monthly cost which might end up costing you more in the long run.
A private loan is issued on a short-term note by a private lender. The loan term is as short as 6 months and can be extended up to a couple of years, instead of a 30-year term like in a traditional mortgage. Private lending includes a solid exit strategy that involves the payback of the private loan - usually this is rehabilitating or remodelling the property and selling it. Notably, private lenders are more focused on the before and after value of the real estate project. So if your project plan shows promise that it will be easily sold, finished on time and on budget, and that the loan will be paid back, you’ll increase your chances of getting your loan application approved.
Private lenders have realized that the rigorous guidelines imposed by traditional mortgages are turning away many individuals who are in fact able to repay loans. In turn, borrowers are learning that private lenders operate differently from banks.
One of the biggest differences between traditional mortgages and private lending is the qualification criteria that a borrower needs to meet in order to get approved. As previously mentioned, banks are extremely critical of a borrower’s financial profile. The process requires a lot of documentation, good credit scores, and verification that you’re able to afford monthly mortgage payments, a down payment, upfront costs and other fees. Whereas private lenders are less concerned with a borrower's credit score and more willing to work with you if you have at least 20% to put down toward the purchase of the property, the capital to pay the interest on the loan, and you present a solid plan on how you intend to pay off it off.
2. Time Frame
Time is a crucial factor in real estate investing. With a traditional mortgage loan, it takes several weeks or even months to close on a loan application. It takes about a week or two, sometimes less to close with a private lender.
3. Interest Rate
Hard money loans rates tend to be higher across the board than conventional mortgages. This is because private loans are short-term, and not 30 years like a traditional mortgage. Higher rates attributed to private lending is also due to the fact that the majority of hard money loans are issued on financing distressed properties that are intended to be fix and flips. Which leads us to our next major difference between traditional mortgages and private lending…
4. Type of Property
Traditional mortgage loans are issued on single or multi-family residential properties that don’t require major rehabilitation or remodelling. Hard money lenders offer private loans for both commercial and residential properties, often making fix and flips their speciality as most banks can’t approve properties that are distressed. It's important to note that private loans are for non-owner occupied properties.