After analyzing a variety of Google search engine results pages, we found that one of the most popular search phrases involving hard money is “hard money vs. soft money.” I live and breathe hard money, but—I am the first to admit—it creates certain myopia when it comes to an understanding what people outside of our industry know about it. Ours is a highly specialized product, but many people, even those who are financially sophisticated, have little understanding of it. A couple of days ago I ran into my former boss, with whom I worked 20 years ago. He is a great, successful man who ran a multi-million insurance and financial services company for MetLife and retired as a multi-millionaire. We started catching up and discovered he has no idea what hard money is—and he is a former financial guru!
What Is “Soft Money”?
First, let’s take a look at soft money. If you are a political consultant, soft money means contributions donated to political parties in a way that leaves them unregulated. In contrast, hard money donations are regulated by law through the Federal Election Commission. For a real estate investor, this might not be the most pertinent information, but it adds an interesting perspective to hard vs. soft money.
A few financial sites do their best to come up with a definition of soft money, some of which do not make any sense at all. You might also notice that any mentions of soft money are all on the hard money lenders’ sites. Go ahead and experiment. Call your local bank and ask to apply for a soft money loan. It’s very likely they will have no idea what you are talking about.
So why are people searching “hard vs. soft money”? The logic is simple. If there is prime lending, there must be a subprime lending. Correct? Yes, indeed. If there are secured loans, there must be unsecured loans, right? Absolutely. However, if there are VA loans, are there loans that are non-VA? No, there is one particular type of loan that is explicitly designed with veterans in mind, and there are all other loans that are open to anyone, regardless of whether they are veterans or not.
What Is a “Hard Money” Loan?
The same is with hard money loans. They are a particular subset of a mortgage market. Instead of searching Google “for the difference between hard money and soft money,” a better search would be “What is hard money?”
First and foremost, hard money is a loan offered exclusively to real estate investors. It’s not designed to promote or encourage home ownership. You’ve probably heard about the many consumer mortgage regulations that came on the heels of the housing crisis. Those regulations capped lender compensation and imposed stricter underwriting guidelines on the whole mortgage industry. Today, 90% of the mortgage market are plain-vanilla mortgages that don’t offer much variation from lender to lender.
Hard money loans are designed to enable investors to make money by investing in real estate. As such, it’s not a consumer loan, but a business loan. Hard money lenders take more risk and charge a fair market price to compensate for it. Those loans must not be confused with subprime financing though. We get quite a few phone calls from folks who want to purchase a primary residence but have been declined for financing by their banks. “Can you help me?” they ask. We wish we could, but no hard money lender can. You are not an investor, and this would not be a business loan.
Hard Money Lenders vs. Non-Hard Money Lenders
To be a hard money lender you have to work with real estate investors. However, many lending institutions do that, and they are not hard money lenders. What differentiates hard money lenders is the types of properties they accept as collateral and the amount of leverage they provide to their borrowers.
Non-hard money lenders (preferably called traditional lenders vs. “soft”) do not lend on properties that require repair. This is why when such properties are shown in MLS, they often come with a note: “Investor Special. Cash Only.” No matter what a good deal that property is and no matter what its after-repair value potential is, traditional lenders won’t budge. Such loans simply exceed their risk appetite. They prefer to concentrate on their bread-and-butter strategy of lending on primary residences or turn-key investment properties.
A hard money lender sees beyond the property’s current condition and lends on the after-repair value. For example, let’s assume you are buying a distressed property in Washington, DC for $400,000. Even if it was your primary residence and was beautifully remodeled, your local bank will only lend you 90-95% of the purchase price. Your total loan amount with them would be $360K.
Let’s assume the after-repair value of that DC property is $750K, and the total repair costs are $100K. The total amount a hard money lender can lend you is around $470K. This is what I call the power of leverage. You don’t need hundreds of thousands of dollars to purchase and rehab a home. A hard money lender will pay 100% of its purchase price and will contribute to its rehab budget.
In essence, hard money lenders allow their customers to borrower amounts of money that significantly exceed the current value of a dilapidated property they purchase. Whether you refer to other lenders as traditional or “soft,” they cannot come close to providing such incredible leverage.
Hard Money Lending in MD, VA & DC
Essentially, hard money loans are based on future potential. However, no matter how great that potential is, that future value does not exist at the point of time a hard money lender issues its loan. Now, you can imagine that such loans are risky for the lender. This is why they cost more than traditional mortgage loan you have on your current residence. Hard money lenders need to be compensated for the risk they are taking.
Hard money lenders develop their own underwriting criteria. There are many differences between them including how much they can lend, how much they charge, and how they service their loans. However, all of them work exclusively with investors and base their loans on your property potential vs. its current value. This is the difference between them and traditional lenders or, as you searched, between “hard money and soft money.”