Hard Money vs Conventional Loan: The Ultimate Guide for Real Estate Investors

Over the years, real estate investors have been dependent on conventional loans for funding their projects, but asset-based hard money loans have emerged as an alternative source of raising quick capital without worrying about the credit score or complex underwriting process of conventional loans. Private lending has boosted the industry with experts estimating the market cap of over $65 billion.

Simply put, a ‘hard money loan’ is a short-term loan secured with real estate and funded by private lenders or individuals. Hard money loans are sourced mostly from private lenders who lend their own money or money from a group of investors.

Conventional loans are also known as ‘conforming loans’ as they conform to the Fannie Mae and Freddie Mac guidelines. Some lenders provide ‘non-conforming’ conventional loans (Jumbo loans) with more flexibility.       

10 Ways Hard Money Financing Differs from Conventional Loans

While conventional loans are looked at as a reliable option, the asset-based, money-building option of hard money loans has become a popular choice amongst private real estate investors. Some significant differences set hard money loans apart from conventional ones.       

1. Primary borrowers

The major difference between conventional mortgage loans and hard money is, conventional loans are designed to attract first-time homebuyers looking for a property that will remain owner-occupied for the long term. This is why they are repaid in 15, 20, or 30 years. 

Whereas hard money loans are specifically designed for private investors looking for an investment opportunity to acquire a non-owner-occupied property at a discount, fix it, and sell it quickly. The structure allows an investor to monetize the property and clear the debt in the span of six months to 2 years.

2. Faster Approvals

When you consider applying for a mortgage, the time-consuming verification process of credit checks, bank statements, credit limits, and other formalities can take up to 6 months for loan approval. Whereas hard money loans can be obtained in a couple of weeks due to a simplified verification process.  

3. Flexible terms and conditions

An advantage of opting for hard money loans over conventional ones is that the terms and conditions of the loan can be negotiated between a lender and a borrower. This is something that conventional loans do not offer.    

4. Minimum Qualifications

In conventional loans, financial institutions look for the overall creditworthiness of a borrower. An investor will require a minimum credit score of 620 to qualify for a loan. Some banks also require borrowers to have a steady income and debt-to-income ratio of less than 50% for loan approval. 

A hard money loan requires fewer formalities and qualifications. A lender will decide to provide a loan primarily on the after-repair value (ARV) of the property. 

5. Less Documentation and Underwriting 

Hard money loans are known for their hassle-free approach towards loan approvals. This also reflects in the documentation and underwriting. Underwriting can be simply defined as a verification process of your income, assets, debts, and property details.

A hard money loan requires very few documents, including but not limited to:  

  1. Purchase contract, 
  2. Two forms of identification (individual investors), 
  3. Preliminary title report, 
  4. Proof of insurance, 
  5. Proof of funds, etc. is sufficient. 

To avail of a conventional loan, you may require some or all of the following documents with underwriting:

For Income verification

  1. Two years’ worth of W-2 forms
  2. 30 days’ worth of pay stubs
  3. Income tax returns of 2 to 3 Years
  4. For self-employed individuals: income tax returns, current profit, and loss statement, and list of all business debts

For Assets and debts verification

  1. Two to three months’ worth of statements such as bank accounts, investment accounts, credit card accounts, and student loans.
  2. Documentation for any large deposits on an asset 
  3. Judicial decree or court order 

For Credit verification

  1. Credit explanation letter, collections, judgments, or any other derogatory items
  2. Bankruptcy or discharge papers (if any bankruptcies in credit history)
  3. Expenses like cellphone, cable TV, car insurance, payment history for utilities, etc.

The type of documents required for a conventional loan may vary according to your unique financial conditions and the lender.

6. Down Payments

The typical down payment for a hard money loan ranges between 10% to 50%, while a conventional loan can be obtained on a down payment of 3% to 20%.  

7. Interest Rates

A hard money loan can have an interest rate between 8% to 15%. Whereas a conventional loan can have a rate of interest between 1% to 6%.  

8. Loan-to-value Ratio (LTV)

In hard money loans, a property is the only protection on default hence the LTV ratio is lower than a conventional loan. Which can be around 50% to 70%. In conventional loans, a borrower is expected to pay at least 20% of the home’s value towards a down payment. Which keeps the LTV ratio at 80%.          

9. Closing Costs 

A hard money lender will typically charge an origination fee of 1% to 3%. Add renovation and construction costs of the newly acquired property. In most cases, the loan-to-value ratio determines the total closing costs related to hard money loans. A high LTV ratio means higher interest rates and associated costs.

In conventional loans, the average closing costs range between 2% to 5% with an origination fee of about 0.5% of the loan amount. However, private mortgage insurance (PMI) is required for loans with less than a 20% down payment.

10. Refinancing

Hard money loans are a great way to quickly finance a real estate investment project like fix-and-flip, rental, or renovation. These loans are a temporary financing option and holding on to them for a longer time can be riskier because of the high rate of interest.  

Once a property is close to reaching its maturity, refinancing a hard money loan to a traditional one is recommended for keeping the flow of cash. A traditional lender will easily provide finance on a property that is in a perfect state and ready to be leased. 

In this way, you get a traditional mortgage loan with lower interest rates and a longer-term repayment. 

There are pros and cons of both options. Here’s a comparison to better view what differentiates hard money “loans” from conventional loans.

Hard Money Loans Conventional Loans
LendersPrivate firms / IndividualsBanks / Financial Institutions
Issuance CriteriaAsset / equity / propertyCredit score 
Down Payment10% to 50%3% to 20 % 
Approval 1-2 Weeks3-6 Months 
Rate of Interest8% to 15%1% to 6%
LTV Ratio50% to 70%80%
Underwriting or DocumentationLesser Higher
Repayment Schedule6 months to 2 years 10 to 30 years
Terms and ConditionsNegotiableNon-negotiable

Closing Words

The bottom line is that a hard money loan is a short-term loan secured with real estate and funded by private investors or individuals. Primarily issued based on the value of the property on offer as collateral. These types of loans are perfect for private investors to invest in real estate flip, rental, or renovation projects.  

Whereas a conventional loan is issued by a bank or financial institution. Conventional loans are best suitable for buyers who want to purchase a property as their primary or secondary home which will remain owner-occupied for a longer-term.   

The process to obtain a conventional loan for real estate investors looking to raise money quickly is hectic and time-consuming. Fast approvals with flexible terms and conditions give an edge to hard money loans over conventional ones.