There are many ways to finance real estate, flip houses or buy and hold properties. However, the wide variety of financing options may not be clear to many borrowers, limiting their access to capital. In this post we discuss hard money vs. private money loans, including their differences and similarities.
Hard Money vs. Private Money – The Basics
Let’s first define what hard money loans and private money loans are.
A hard money loan is a loan made for a defined period of time, with a set interest rate. It is secured by the real estate it is used to purchase, along with other cash or non-cash collateral. Hard money lenders recover their loan money by being paid back the agreed principle + interest, or by foreclosing on the property and selling it, should the borrower default.
A private money loan can vary in its maturity. It may not have a set interest rate. The lender may retain an equity interest in the property, or have the ability to convert the loan into equity. The loan is secured with the real estate it is used to purchase. Private money lenders recover their investment by participating in the overall returns of the property, not just principal + interest.
Differences Between Hard Money Loans vs. Private Money Loans
Difference #1: Hard Money is Short Term. Private Money is Long Term.
Hard money loans are a short term type of financing that mature in 1 year or less. Hard money loans are meant to enable investors to purchase and improve a property, then either sell it or refinance the loan and hold it. Their maturities are typically 3-6 months, but no more than 1 year.
Private money loans tend to be much longer term in nature with a much longer payback window. Private money enable investors to purchase and improve a property, then hold it for long periods. Their maturities can be 3, 5 or 10 years, or have no maturity at all.
Difference #2: Hard Money Lenders are Professional. Private Money Lenders MAY be Professional.
Hard money lenders are typically professional lenders, with a favored type of loan structure and property. Their business is highly transactional. To generate sufficient profits they must make a lot of loans. They also must have a well-managed process for foreclosing on borrowers who default and liquidating their properties.
Any hard money lender you use should be properly licensed and professional because they are in the business of lending. They all have similar processes for loaning out funds and follow their local and state lending regulations.
Finding hard money lenders is easy. You can find a directory of hard money lenders here. Talking to other real estate investors, agents or brokers can give you plenty of connections in your area.
Private money lenders can be any individual or entity that has cash sitting in an account and is looking to invest it in real estate. These lenders can be any wealthy individual, trust, or private investment fund.
Private money lenders have minimal licensing, legal or regulatory obligations (except usury and perhaps securities rules). They don’t have to follow standard lending processes. They are not necessarily tied to the lending or real estate industries.
Some private money sources include:
- Financial professionals
- Small business owners
- Private real estate investment companies
- Family trusts
- Anyone with money sitting in the bank who want to get into direct real estate investing
- People looking for higher returns on their investments
Difference #3: Hard Money are Lenders. Private Money are Investors.
Hard money lenders loan money and earn interest and fees from the borrower.
Private money, on the other hand, often includes investors seeking to take part in a real estate deal through profit sharing.
Private money lenders are often involved with other businesses beyond real estate. As a borrower, you need to show the private money lender you are serious, trustworthy, and know how to generate value from real estate.
Difference #4: Private Money Has Lower Interest Rates Than Hard Money
Interest rates are negotiable with private money lenders and can range between 7-15%. If a borrower puts the lender on the first Trust Deed position, then the rate can be on the lower end of this. It all depends on the risk and potential returns the private money lender perceives on the deal.
Hard money lenders tend to charge higher interest rates from 10-20%. This is because most short-term real estate deals carry a lot of risk. The borrower must purchase, rehab and flip or rent the property quickly. There is no opportunity to participate in the long-term growth in equity value of the property. So the lender can only charge interest and fees, and try to recover by foreclosing if the deal goes bad.
Difference #5: Hard Money Closes Faster Than Private Money
Hard money lenders operate very efficiently to originate, review and fund loans. Larger hard money lenders are very similar to “loan factories” because their business model only makes money if they have a lot of loans outstanding.
Private money, however, is often relationship-based. The loan approval process is not standardized and requires developing trust over time. Potential deals must be presented and discussed ahead of time — much earlier than a “quick flip” investor would typically do when applying for a hard money loan. This makes private money best for more creative or complex deals.
Similarities Between Hard Money Loans vs. Private Money Loans
Similarity #1: Both are Asset-Based
Both hard money and private money lend based on the value of the asset (the real estate and any additional collateral).
Hard money lenders base their loan amount and interest rate on collateral or security value — what they could sell the property and any additional collateral for to recover in a default situation.
Private lenders base their loan amount and interest rate on the growth in the real estate’s value and/or cash flows.
Similarity #2: Both Care Less About Credit History Than Traditional Lenders
Hard money lenders and private money lenders are both minimally concerned with a borrower’s credit history. They rely more on the perceived deal value, reputation and trust they have in the borrower to succeed.
Although the borrower’s credit rating is not high on the list of priorities for both lenders, they will likely do a credit check. This practice has risen in recent years after the financial crash of 2007-2008 when many hard money and private lenders suffered from borrower defaults.
Similarity #3: Both Require “Skin in the Game”
Having a down payment for a hard money loan, and investing your own money with a private money loan are both necessary. Both lenders want to know you are committed to the deal by putting your own funds on the line. Both require similar down payments — around 25-35% of the total deal value.
Similarity #4: Both Provide Funding Quickly
Both private money loans and hard money loans share a common trait: speed. You can secure financing quickly from either type of lender when a great deal presents itself.
You can get financed within 48 hours with a hard money loan, and within 3-5 days with a private loan. Funding speed depends on your level of prior preparation and the lender’s availability and willingness to complete the necessary due diligence and release the funds.
Similarity #5: You Can Find Both Lenders at Investor Gatherings
Going to investor meetups and investing groups can provide you with solid leads for private and hard money lenders. At these events you can also develop relationships with other successful real estate investors that might want to partner with you on future deals.
Similarity #6: Both Are On the Trust Deed
Both hard money and private money lenders take steps to ensure they can get their money back from the property if the deal goes sour. They both require that you add their name near the top of the Deed of Trust.
Similarity #7: Both Have A Similar Lending Sequence
The sequence of events is basically the same:
- You find the deal
- Contact your private money or hard money lender
- You provide details of the deal
- Request the funding
- You buy the property
- You rehab / flip the property
- Pay back the loan and any additional fees or proceeds per the loan agreement
Similarity #8: Neither Lends to Individuals
Neither private money lenders nor hard money lenders make personal loans. Hard money landers will lend only to business entities such as LLCs, S-corporations, C-corporations, and Trusts.
Consumer lending laws strictly regulate the types and terms of loans made to individuals. These regulatory requirements, and the penalties for any infractions, are too ominous for hard money or private money lenders. So if you’re seeking either type of loan, you should borrow using a legal business entity.
Similarity #9: Both Hard Money and Private Money Loans Require Full Repayment
Both are loans and must be repaid by the borrower. Private money lenders may be more flexible in the timeframe of repayment, but the loan must be repaid nevertheless.
Similarity #10: Both Require the Same Documents
Documents shared include:
1. Purchase contract
2. Preliminary Title Report, provided by the title company
3. Two Forms of Identification
4. Corporate documents or operating agreement.
5. Certificate of Good Standing from the Secretary of State if borrowing as a business.
6. Statement proving borrower funds
7. Proof of Insurance
Additional items depend on the lender and include credit report, lease and rent documents, and loan application. It is recommended that borrowers check with their lender for the required documents upon pre-approval of the loan. Having them ready to go will speed up the process of getting your financing.
Additional Hard Money vs. Private Money Considerations
Flexibility is a big differentiator in hard money vs. private money loans. The primary advantage of a private money loan is the ability to negotiate with the lender. Private lenders are able to structure loans in creative ways, including custom repayment schedules, interest rates, and equity participation schedules. Hard money lenders may have some latitude, but are generally not as flexible.
Finding a Good Lender
Hard money lenders are easy to find. Just check out our hard money lenders directory for all 50 states here.
On the other hand, private lenders are more difficult to find and build a relationship with. The best way to find a private money lending partner is to network with friends, business colleagues, and acquaintances in real estate. Ask if they know investors looking for new real estate deals.
After being introduced to a private money lender, feel free to discuss what you do, the potential returns on your real estate deals, your own investing experience, and your ability to handle complications inherent with real estate. Provide details of past property flips, rehabs or multitenant deals. Share any issues you were able to overcome.
The key is to build up a private money lender’s trust in you. When you have a deal planned out, you can then reach out to elicit their interest.
Use Hard Money Lenders As a Backup
If you prefer private money over hard money, you can always use hard money loans as a backup. These are best for borrowers that have run out of financing options, and have a short-term deal with high profit confidence.
Hard Money vs. Private Money Loans – To Recap
Hard money and private money loans have their similarities and differences. It is up to the borrower to decide which form of funding is best for their real estate investing goals. Make sure to be cautious and take your time deciding on a hard money vs. private money loan.