One of the knocks against hard money lending is its tendency to assess higher interest rates. Rates can be several percentage points higher compared to traditional lending. But that is not a problem for hard money borrowers. They know about the higher interest rates going in and they are okay with it.
If you have never had occasion to borrow hard money before, you might not get it. You might scratch your head wondering why a real estate investor would pay a higher rate on a hard money loan rather than securing traditional financing. Let me just say there are plenty of reasons for gladly accepting a higher interest rate.
Hard Money Is Private
It must first be understood that hard money comes from private lenders. Private lenders, like Salt Lake City based Actium Lending, aren’t required to follow the same rules and regulations institutional lenders are bound to. A different set of rules allows Actium to do business differently in Utah, Colorado, and Idaho.
This is to say that Actium and its competitors are free to set interest rates as they please. More often than not, they go higher than institutional lenders. But they are free to set rates on a case-by-case basis. They can go higher or lower than banks, or they can match local banks point-for-point.
They tend to go higher because hard money lending is also more risky than traditional lending. Higher interest rates accomplish two things for lenders: they reduce financial risk and they help to weed out borrowers who are not really serious.
From the Borrower’s Perspective
It is not hard to understand why lenders like higher interest rates. But what about borrowers? Why are they okay with pain interest at a rate that could be several percentage points higher? There are two things to consider:
1. Loan Terms
Hard money loans rarely have terms exceeding 24 months. Actium Lending says 6-12 months is the norm. Contrast that with traditional loans that can have terms of 5-30 years. The total amount of interest paid on a 6-month loan should be considerably less than what would be paid on a 5-year loan, even at a rate that is several percentage points higher.
The fact is that loan terms are a bigger problem than interest rates. The longer a term is, the more total interest a borrower tends to pay. People do not realize this. Instead, they focus only on interest rates. But savvy hard money borrowers are different. They understand the trade-off. They know that shorter terms offer a better deal.
2. They Don’t Want to Miss Out
Even if shorter terms don’t save borrowers money in the long run, there is a second reason for being okay with higher interest rates: the ability to close deals quickly with hard money.
Understand that most hard money loans go to real estate investors. An investor does not want to miss out on a lucrative opportunity just because a hard money loan comes with a higher interest rate. The piece of property he is targeting will more than pay for itself – and the loan, too – if he can just secure it. And in a highly competitive market, securing a lucrative property often hinges on arranging financing quickly.
Speed and hassle-free lending are the two most attractive aspects of hard money. Both contribute to helping borrowers meet their financial goals. For this reason, they don’t mind paying higher interest rates. Loan terms keep total interest under control and the right properties more than cover the cost of higher interest rates. So the higher rates are not such a big deal.