How much do you know about hard money lending? If you are like most people, your knowledge is limited. The lack of such knowledge among the general public has led to multiple misunderstandings about hard money and the industry behind it. Among the misunderstandings is the biggest one of all: interest rates.
Hard money lenders charge interest rates that tend to be at least several points higher than the current rate on traditional loans. Salt Lake City’s Actium Partners confirms that. Actium Partners is a hard money lender that provides most of its financing to commercial property investors.
They explain that lenders in the hard money industry charge higher rates because the loans they make are risky. Some of the excess risk is mitigated by higher interest. So what’s the problem? The mistaken belief that higher interest rates make hard money loans less affordable than their traditional counterparts.
Rate Is Only Half the Equation
Looking at straight interest rates alone makes it appear as though hard money loans are prohibitively expensive. But rate alone is only half the equation. In order to make good money, lenders also need time. It is the combination of time and interest that costs a borrower so much.
On a typical 30-year mortgage, interest is calculated annually. Let us say you have a mortgage at 5%. The total amount of interest you pay during the first year equals 5% of the balance due at the start of the year. When you make it to year two, interest is recalculated at 5% of your outstanding balance. This recalculation continues for 30 years.
Using a standard online mortgage calculator, I ran a $300k mortgage at 5% with no PMI or insurance costs included. Over thirty years, the total interest payments amounted to $279,767.35. That is almost equal to the amount of money I borrowed. What if I could pay off the same mortgage in just three years? My total interest would be a comparatively low $23,685.69.
Short-Term Hard Money Loans
It is not uncommon to read about hard money loans being expensive. They are expensive when you look only at the interest rate without considering time. Here is what most articles critical of hard money do not tell you: hard money loans are short-term loans. Most have terms of 6-24 months. Rarely does a hard money term go beyond 36 months.
Paying 15% interest for three years is still cheaper than paying 5% interest for 30 years on the same amount of money. How much cheaper? Using the same $300k loan at 15% for just 3 years, total interest payments work out to be $74,385.55. So even with an interest rate 10 points higher than a conventional 30-year loan, the borrower still spends $200k less on interest payments.
Loans for Specific Uses
Something else to consider is what hard money loans are used for. Oftentimes, articles critical of hard money don’t mention the fact that it can’t be used for a residential mortgage. Hard money firms like Actium Partners do not fund the acquisition of owner-occupied homes.
Hard money is almost always used to fund real estate investments. It would be impractical to fund owner-occupied purchases because homeowners simply could not afford to pay off their loans in 36 months or last. They need 30 years. But in the end, taking that much time to pay costs a homeowner a lot more in total interest.
Interest is one of the most misunderstood aspects of hard money. When you factor in time, higher interest rates are not as bad as they look.
