Understanding Hard Money and Soft Money Loans

David Cohn
Aug 11, 2021
Hard Money Loans

A hard money loan is a financing option that lets you borrow money without going to a bank or a similar conventional lender.

Instead, it is backed by investment companies or individual professional investors who are in the business of lending money to commercial property borrowers based on the value of the property being used as collateral.

The great thing about hard money loans is that they get approved and released much quicker than traditional financing. This allows commercial property investors to compete against cash buyers and quickly close on good deals before the competition can get to them.

Unfortunately, hard money is generally available only for commercial investment properties that are not owner-occupied.

In this blog, we’ll discuss what hard money loans are and how they compare to their cousin—the soft money loan.

Explaining hard money loans

Ironically, ‘hard’ money loans are not that hard to obtain; in fact, they are some of the most straightforward commercial property loans to qualify.

The word ‘hard’ refers to the underlying hard asset—the commercial property that serves as the collateral on a loan.

Hard money is often considered ideal for fix-and-flip properties and other short projects lasting a few months to a few years.

This short-term financing option does carry higher interest rates and fees compared to traditional loans, but they can be the best option in some cases, such as when:

  • The commercial property’s condition does not meet the stringent requirements of banks (as in the case of fix-and-flip buildings that need renovation before selling)
  • Funding is needed to meet immediate contract deadlines for a deal, and the borrower doesn’t have time to wait for conventional financing.
  • The borrower’s debt-to-income ratio does not meet the standards of traditional lenders.

If you have ever tried to get a loan from a bank, you already know that they take several weeks (even several months) to close. Banks also need extensive documentation from borrowers.

What’s more, they only lend money for properties that they consider to be in good condition—with water, working electricity, no missing flooring or fixtures, no major broken windows or roof issues, etc.

Unfortunately, this means that most commercial properties that can potentially make a good profit when renovated and flipped don’t meet the requirements of traditional banks.

This is why many investors—even those with sizable portfolios and are successful in the industry for many years—turn to hard money lenders for specific projects. These lenders are usually experts in commercial real estate investment.

They understand the business and the unique needs of investors in this niche and are ready to be flexible to meet different requirements.

For example, hard money lenders do not focus too much on the creditworthiness or income of the borrower. They instead look at the value of the property itself and lend money based on that.

They realize that many investors have their funds and assets tied up in other properties and that just because their credit scores are low doesn’t mean that they are irresponsible with money.

That said, it’s important to note that different hard money lenders operate differently.

Some of them will still require the borrower to meet a specific credit score. Some will ask for documentation showing the borrower’s credit history and personal assets. But most of them don’t.

Some hard money lenders lend funding for property repairs, while others do not.

Some are willing to lend to borrowers who have low credit scores, provided that they have extensive experience as commercial property investors.

And some lenders are willing to give you 100% of the property’s purchase price plus the entire cost of repairs for as long as the total loan amount is still below 65% to 70% of the after-repair value (ARV).

Should the project fail to meet that ARV threshold, you will need to put money at purchase to meet that ratio.

As you can see, there are different types of hard money lenders, and not all of them will be the right fit for you as a borrower. This is why it’s important to work with a commercial mortgage broker to find the right lender that suits your project’s requirements.

Is it true that hard money loans are expensive? Yes, but they are worth it if you know what you’re doing.

The interest rate on hard money financing usually falls between 12% to 16%.You may also need to shoulder origination fees that cost anywhere from 3% to 5%. There are closing costs, too. The higher fees and rates ultimately eat into your profit in the end, but hard money remains a good option if the deal is right.

Explaining soft money loans

If you have never heard of commercial hard money loans, then you probably have heard of soft money loans, too. Soft money lenders have cheaper fund sources compared to hard money lenders.

They typically require borrowers to put some skin in the game in the form of a sizable down payment.

This allows them to lend ‘cheaper’ money to commercial property borrowers, which could mean more profit for you in the end.

The actual values will vary, but in general, a soft money loan worth $300,000 can be cheaper by $7500 to $10,000 than hard money.

Soft money lenders can also close quickly, just like their hard money counterparts. You can expect to get the money within a week (sometimes in a matter of hours if you have successfully worked with them before).

The documentation requirements and underwriting processes for soft money loans are similar to those of hard money loans. Some soft money lenders are willing to finance repairs and lend money for fix-and-flip properties.

How much of a down payment do you need to come up with to qualify for a soft money loan?

In general, you have to be prepared to put down at least 10% of the purchase price, plus another 10% of the repair costs if you’re borrowing that, too.

The total loan amount needs to be 75% or less of the ARV. Most soft money lenders require borrowers to have good credit, so be prepared to show a credit score of at least 680.

If you don’t meet these credit score requirements, you may need a bigger down payment. You can also bring in a qualified cosigner if the lender allows this.

Should you get hard money or a soft money loan?

The answer depends on the nature of your project, your immediate requirements, and your exit plan. Overall, both hard and soft money can be handy in some instances.

It’s essential to do your due diligence and carefully weigh your options before pursuing any loan.

Take note of factors such as interest rates and other fees, qualification standards, and how long it will take for your application to be approved and funding to be released.

If you are unclear about any of the terms proposed by the lender, be sure to ask. You can also talk to a commercial mortgage specialist to understand your options and decide on the best type of financing for your commercial property project.