Understanding the distinctions of these loan types creates a competitive advantage
The terms “hard money lending” and “private lending” are often used interchangeably, creating confusion among borrowers and investors alike. While both fall under the umbrella of private money lending, it’s crucial to understand that they are distinct financial instruments with unique characteristics.
In 2022, both the American Association of Private Lenders (AAPL) and the National Private Lenders Association (NPLA) passed resolutions that urged members to cease using the term ‘hard money’ on their websites, marketing materials and communications. Still these terms are commonly used in the marketplace even today. Understanding these terms and being able to define them clearly to clients and investors is crucial.
As a mortgage originator, being well-versed on the unique advantages of these lending type positions will enhance your role as a valuable resource for clients with specific needs. By understanding the scenarios where traditional financing falls short, originators can guide clients toward viable alternatives that align with their objectives.
“As a mortgage originator, being well-versed in the unique advantages of lending type positions you as a valuable resource for clients with specific needs.”
Hard money
Hard money lending, as it has been traditionally known, is a form of private financing where the loan is secured by the value of the underlying real estate. Unlike traditional loans from banks, hard money lenders are typically private individuals or small groups who focus mostly on the asset’s value, rather than the borrower’s creditworthiness.
These loans are often short-term bridges, ranging from a few months to a few years and carry higher interest rates compared to conventional mortgages. One defining feature of hard money lending is the emphasis on the collateral’s quick resale value.
These loans are commonly used by real estate investors who need fast access to capital for property acquisitions, renovations or quick turnaround projects. Hard money lenders are traditionally willing to take on higher risks in exchange for the potential for substantial returns.
Private lending
Private lending, on the other hand, is a broader term encompassing various lending arrangements between private individuals or entities. It includes a spectrum of loans, not limited to real estate, and can involve family members, friends, private investors, hedge funds, and other non-bank investors. Private lending extends beyond the realm of hard money, as it can involve long-term loans, lower interest rates, and less emphasis on the collateral’s immediate resale value.
While hard money lending is a subset of private lending, the key difference lies in the specific characteristics and goals of each. Private lending allows for more flexibility in terms, repayment schedules and the nature of the loan, making it a versatile option for various financial needs.
“A nuanced understanding reveals that hard money lending is a subset of private lending, emphasizing real estate-backed, short-term loans with higher risk and return profiles.”
The interchangeable use of hard money lending and private lending stems from their shared characteristic of being outside the traditional banking system. A nuanced understanding reveals that hard money lending is a subset of private lending, emphasizing real estate-backed, short-term loans with higher risk and return profiles. These loans are based on the asset itself, with no requirement for credit or tax returns for approval.
Non-qualified mortgages
In the realm of private financing, another term “non-qualified mortgage” (non-QM) has also gained prominence. A non-QM loan is a type of mortgage that doesn’t meet the stringent criteria set by government-sponsored entities like Fannie Mae or Freddie Mac. These loans are often more flexible in their underwriting standards, accommodating borrowers who may not qualify for traditional mortgages.
It is important to note that non-QM loans are not really synonymous. While both involve alternative financing, non-QM loans pertain specifically to mortgages that don’t conform to conventional standards.
These loans still require a credit score, tax returns and accompanying documentation for approval. Private lending, on the other hand, spans a broader range of financial transactions beyond real estate and includes various loan structures.
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While both hard money lending and private lending provide alternatives to traditional financing, it’s crucial for borrowers and investors to recognize the distinctions. The diversity within private lending offers flexibility to meet varied financial needs, whether it be a quick property flip or a long-term investment. Understanding these differences empowers individuals to make informed decisions that align with their specific goals and circumstances in the evolving landscape of private financing.
Author
Michael Internoscia
Michael Internoscia is a principal partner at M&M Private Lending Group, which does business in Florida, Colorado and New York. Internoscia has been a licensed real estate broker and mortgage broker for 20-plus years. His focus has been in the residential investment-property markets for foreign nationals and Northeast investors. He has worked in the trenches in the mortgage industry, assisting investors and real estate agents. Nine years ago, he entered into the private-lending business.
