I recently read the latest in a lengthy list of posts describing a pair of real estate investors who use hard money to finance their acquisitions. The investors do both fix-and-flip and invest in long-term rental properties. And like so many other posts just like it, this one conflated higher interest rates and higher costs, expressing what seemed like surprise the investors would go with hard money.
The post’s opening paragraphs reported how real estate investors are sometimes willing to pay interest rates that are twice as high in order to get hard money loans. The surprise so many blog writers express in these types of scenarios is based on the false assumption that higher interest rates automatically equal higher costs for the investor. They do not.
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Real Estate Investing Is the Big Thing
The basis for understanding hard money and its appeal is knowing that real estate investment is the big thing in hard money. In other words, the vast majority of hard money loans go to real estate investors looking to purchase either long-term rentals or fix-and-flip properties.
Actium Lending is a Salt Lake City, UT hard money lender that specializes in loans for commercial real estate investors looking to obtain office buildings, warehouses, strip malls, and the like. Actium does not do any fix-and-flip projects. Plenty of others do.
The main takeaway here is that most of the investors looking at hard money would struggle to get a traditional bank loan. And even if they could get such a loan, it could take months for the bank to get things in order. Real estate investors do not have that kind of time. Still, why are they willing to pay rates that are at least several percentage points higher than traditional lenders?
It is all about the term. Loan terms mean everything when it comes to total costs. In fact, terms have the single largest impact on the total amount of interest a borrower will pay.
Hard Money Terms Are Short
Actium Lending explains that hard money terms are very short. That is by design. Terms of 6-24 months are normal. Rarely will a lender exceed 24 months. Now, consider such a short term and what it means to interest payments.
Interest on a hard money loan is calculated annually, just like a traditional loan. So an annual rate of 12% yields monthly interest payments of 1%. Taking out a $100,000 loan at a rate of 10% over 12 months would result in total interest payments of just $10,000.
Take that same loan and reduce the interest rate to 7%. Now extend the term to five years. Your total interest jumps to more than $18,000 even though the rate is three percentage points lower. Why? Because you are paying interest over a longer term.
Real estate investors have no intention of paying on loans for five years or longer. They wouldn’t even think about a 30-year mortgage. The interest would suck up all their returns – and then some. They willingly pay a higher rate with a shorter term and still come out in a better financial position.
Hard Money Offers a Lot
From the investor’s perspective, hard money offers a lot. Investors are willing to pay higher interest rates in exchange for faster approvals, faster funding, fewer hassles, and shorter terms. Make no mistake about it. They are making money on their investments despite paying higher interest rates. That is what so many bloggers fail to grasp when they write about hard money and its importance to real estate investors and small businesses.