Ask Cornerstone: Why do house flippers pay much higher rates to private money lenders when banks only charge 4-5%?
First, I’ll explain the difference between the two types of loans. Conventional loans loans from banks are given to homeowners who meet lending criteria in regards to debt-to-income ratios, credit scores, and several other guidelines. All the major systems such as plumbing, electrical, heating, and roof, need to be in good working condition. Private mortgage insurance is also required when the borrower has less than 20% equity. These loans typically take four to six weeks or more depending on problems found in the application process. The lower interest rates reflect that it is a relatively safe loan to the lenders.
Hard money loans (HML) are made by financial companies or the companies that raise the funds from private individuals, like you and me, not banks. The primary protection to the lender is in the equity of the property so, consequently, the borrower typically puts a 20%-30% down payment. HML can be borrowed by those with lower credit scores and for properties that need repair or to be leased up. These hard money loans typically have 1 to 2 year terms and they take 1 to 2 weeks to fund. The higher interest rates are to offset risk and due to the “down time” between loans when the money is temporarily less productive.
In understanding the differences, house flippers use hard money loans and pay a higher rate because 1) they or their purchases don’t qualify for a conforming “conventional” loan, so they can’t get lower rates, and 2) because of the speed in which they need and can obtain the money from a hard money lender.