They say that hard money lenders are the solution to any real estate investor’s funding impasse. On top of that, there’s been an evident confusion on the difference between hard and private money. What are the distinctions despite seen similarities? Which one should you prefer if you wanted to scale up your business? Learn the top three answers to what makes them poles apart when it comes to funding deals.
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The Difference Between Hard Money And Private Money
Intent, Flexibility And Rates Are The Key
I want to take a moment and welcome you and also thank you for sharing your time with me. For this episode, I will attempt to answer a question that I hear a lot in the REIA or Real Estate Investment Association meetings in the community and yet hearing it in the flesh and then seeing things online. To me, there’s some confusion there. That is the simple question of what is the difference between hard money and private money? You can start with things like the difference in the terms. Both hard money and private money can be very short-term. In fact, most hard money loans are short-term, six to twelve months. However, the difference with private money is I have some loans that are out three years. Some lenders will provide landlords a ten to fifteen-year loan at a relatively reasonable interest rate at 5%, 6% and they’re completely comfortable with it. That wouldn’t be me.
However, the real difference for me comes down to the intent and it’s not the intent of the loan or the intent of the property or the transaction. It’s the intent of the individual. For me, a private money lender or a private mortgage note investor is someone who is typically not in the business of making loans. It’s not Wells Fargo or Quicken Loans or name your mortgage company or big bank. Those companies are in the business of making loans and deriving their profits from the interest rates and the points charged. A hard money lender, like the banks or mortgage companies, is in the business of making loans and deriving business income off of those loans. The difference is a hard money lender will typically go to someone like myself or you who want to be a private lender and borrow at say 8% or 9%. Turn around and then loan that money out to an investor at a much higher interest rate. They get the points most of the time.
As long as it's our money, it's our choice.
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Some hard money lenders will pay the first lender much more, 10%, 11%. However, when they loan it out to the investors, they’re pulling off points and possibly the spread, the difference in between that interest. That’s a business. That’s not what I do. It’s not what I talk about when I talk about private money lending, private mortgages. That is in and of itself the biggest difference for me. When people ask me the question, that’s what I like to start. If you go online and I see there’s a private lender association, what it is are businesses that loan money to other businesses which, in a way, that’s what a private lender does. However, these people have offices and staff and it’s their job to look for financing for real estate deals or perhaps they could make loans for inventory or on accounts receivable. They’re often a different thing than giving somebody like my partner lending some money to buy a house and wrap it and sell it. The intent is the biggest thing. It makes the most sense if you look at it from that aspect to begin with. You can look at the terms.
Most hard money lenders aren’t going to be as flexible as a private money lender. Any hard money lender, and I tell this to private lenders, is always get some type of monthly payment. That way, you have a mechanism for foreclosure. Don’t do a twelve-month loan with no payments due until the end of that twelve months and then in those twelve months, that house is sitting there. You could have done something to foreclose on it, but you can’t for a year because you have no trigger for default at that point. A hard money lender would never do that. I would suggest private money lenders never do that, but things are much more flexible on the private money side because many more things are open to negotiation. For example, the collateral. I have loaned money against property A so that the investor could go take care of property B. A lot of banks and hard money lenders will do that as well in the collateralization. However, I’ve also known some people to collateralize boats, RVs, basically anything that has a title and can be repossessed.
I have known extreme cases where somebody has placed a very valuable piece of family jewelry in escrow at an attorney’s office for collateral. I guess it would be okay if it covers the price. That makes me whole if things go south. As a private lender, I think about that thing. These are some examples of the way you can get creative with collateral. You can go back and read episode number 59 with Nomi Yah when she talks about hypothecation and how she wants to construct her deals and her notes for cashflow. Tom Berry touched on that in episode 43 briefly with fractionalizing the loan. You can get some pretty creative things. You have a lot more flexibility as a private lender. Unfortunately, that also means that people can pull the heartstrings of a private lender sometimes a little more because it’s not a business.
A hard money lender can look at a desperate investor in the eye and tell them, “I’m sorry, this deal doesn’t make sense.” When that investor says, “If I don’t do this, I go out of business or I have to go back and get another job or whatever.” A hard money lender is a businesswoman or a businessman. They’re going to look that investor in the eye and say, “This doesn’t fit the criteria.” To me, that is one of the few flaws and differences that private lending does have. If you’re a softy pussy cat, “That’s okay.” Private lending is not going to be for you. You can be a little generous here and there. You can always waive late fees if it’s a little late. There are mechanisms you can show mercy as a private lender. You’ll see that more and more with private lenders above hard money because hard money is business. I am trying to, as I go through this journey, meld those two things together. To be the Republican and the Democrat, as George Bush said, “The compassionate conservative.” I want to help people build neighborhoods. I do want responsible investing.
I once had a professor that didn’t like his pension was tied up in Raytheon. It was a defense contractor. He didn’t like that and wanted his money out. He fully admitted he loved the return, but he didn’t like the fact that his money was with a defense contractor. I can respect that. With the real estate investing, the private lending you can have the element of conscientious lending, giving people chances, so on and so forth. It’s not all cut and dry, but I would highly recommend you start your foundation cut and dry. When the lines get blurred and you go from the black and white into the gray a little bit, at least you have some type of good footing and a good foundation from which all of your decisions are made. That’s why I say let’s take it real conservative in the beginning because you can always loosen up a bit, especially once you get going that you can start with the rates.
For example, the number three difference. Private lenders have this wonderful little area that we can sit in between what the banks are charging and what hard money is charging. If you look at money as how much does it cost and that is out of pocket interest rates, points, time, processing the application all that stuff. Banks are traditionally lower. You can get a 30-year investment mortgage, 20% down between 4.5% to 5% depending on what part of the country you’re in. I’m going to use some bank rate stuff here. You can get a fifteen-year investor loan, 20% down and you get closer to 4% or under 4% in the rates. Whereas hard money is traditionally 12%, 15% or in some cases 18%. It depends on the usury laws of whatever state that you’re in. In Texas, it’s 18%. That includes points and interest rates. I have seen loans that go out with three points and 15% interest or two points and 16% interest. I’ve also seen one that was five points of interest and a 10% interest rate monthly or annualized, non-amortizing interest only.
We as private lenders live in that sweet spot in between what the banks charge, not only on the numbers, points, interest and hard money. That leads the question this is all well and good, but some of you may or may not remember. If you’re reading this blog, you are either my age or older. That means you remember the 1980s. You remember the housing market and what happened. Normal mortgages were at 10% and 13%, regular mortgages, Freddie, Fannie stuff. It got crazy with interest rates. That begs the question, “What’s that going to do between hard money, banks and private lenders? What does that mean for them?” It’s going to squeeze this out from a number’s perspective. That means if we continue, we’ll have to get more and more creative because we are private, we’re not businesses, we’re not regulated. As long as it’s our money, it’s our choice. That’s what I’m looking forward to and fearing at the same time.
It’s going to be interesting to see. We have this nice sweet spot that we’re in between banks and hard money lenders. With the blockchain coming, it is going to radically change the landscape, but we might not be talking about banks and hard money lenders in ten, twenty years. It might be a person to person. That whole industry may go away. We don’t know. It’s going to be cool but I hope I live long enough to see it and to be able to shift and to pivot around that when the interest rates rise. We’ll see what happens. Usury rates are at 18%. They may go up. I would love to own a lending business in North Dakota. The simple reason is because of their usury rate is tremendously high. In fact, most of your credit cards are domiciled in North Dakota.
The world is your oyster. You can write up anything as long as it's legal.
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In recap here, the main difference between hard money and private money. Number one is the intent. Is the lender for business or is the lender an investor? Maybe someone has a regular job or isn’t a real estate investor, has an old 401(k) but they’re not using it to derive consistent business income, but rather investment income. Number two, the flexibility on the terms and the collateral and what you can do as a private lender. You don’t have to answer to a board. It’s your call, it’s your negotiation. The world is your oyster. You can write up anything as long as it’s legal. That’s why you have to have a lawyer but within reason. You can negotiate that RV as collateral for a quick fix and flip. Number three, the rates. Stay between the rates, especially while we have it good as private lenders and let’s make sure that interest rates stay low. That’s my political message. Let’s make sure that interest rates stay reasonable and necessary, but low.
I do appreciate you reading this. I want to tell you to stick around. I’ve got some cool interviews lined up. I’ve got some attorneys. You’ve read about them so far and they’re only going to get better and hopefully a little bit wilder. I hope they would deliver value to you. If they do deliver value, please go to iTunes, Google Podcast, Stitcher or SoundCloud and leave me a rating and review, please. That helps spread the word. It brings people awareness, people like you and me. We can find it a little easier. I would appreciate that greatly. Connect with me over on social channels: Facebook, Instagram, Twitter, LinkedIn and BiggerPockets. I do peruse those channels. Until next time, I wish you all a prosperous and happy investing in private lending. Take care.
- Real Estate Investment Association
- Episode number 59 with Nomi Yah
- Episode number 43 with Tom Berry
- Private Lender Podcast on iTunes
- Private Lender Podcast on Google Podcast
- Private Lender Podcast on Stitcher
- Private Lender Podcast on SoundCloud
- Private Lender Podcast on Facebook
- Private Lender Podcast on Instagram
- Private Lender Podcast on Twitter
- Keith Baker on LinkedIn
- Keith Baker on BiggerPockets