For real estate financing, investors have two primary options: conventional loans and hard money loans. These financial instruments cater to diverse needs, with conventional loans emanating from traditional financial institutions and hard money loans representing a more dynamic and private sector. To determine the best option, investors need to understand the intricacies of hard money real estate lending rates, the basics of how their rates are determined, the relationship of hard money rates and conventional rates, the influence of Federal Reserve policy on the interest rates, and the negotiability of these rates.
First, and I acknowledge that this may be a review for many, it is essential to know what the categorical differences between he two types of lending are. Especially because the differences in play a part in the pricing models and the rate that an investor will secure.
Conventional Loans: Conventional loans, the stalwarts of real estate financing, originate from established financial institutions such as banks and credit unions. The terms Fannie and Freddie loans refer to conventional lending and mean loans originated for sale to or in accordance with the guidelines of these entities. Governed by stringent guidelines set by these entities, conventional loans are characterized by lower interest rates and extended repayment terms, making them a favored choice among residential homebuyers. While they offer investment products, they are governed my more restrictive guidelines and regulations than other options.
Hard Money Loans: On the other hand, hard money loans emerge as the unconventional options in real estate financing and are designed specifically around investors. Typically facilitated by private entities or individuals, these loans deviate from traditional norms by prioritizing collateral value over borrower creditworthiness. Hard money loans, while carrying higher inherent risks, are characterized by their agility and responsiveness, especially in situations demanding expeditious decision-making and flexibility. This flexibility, however, is mutually exclusive of the regulations and guidelines that mark the conventional world, so they do not offer owner-occupied financing options.
While all of this is great, what investors really care about is how the loan impacts the rate that they will get and which is the best way to go.
Determination of Rates:
In the realm of hard money loans, the calculation of interest rates takes a distinctive route compared to conventional loans. While conventional rates hinge on factors such as the borrower’s credit score, income, and overall economic health, hard money rates pivot primarily on collateral value and perceived risk. This means that rates will vary more significantly from borrower to borrower but also from deal to deal as the lender must sufficiently cover their risk.
Hard money lenders scrutinize the property’s potential value and the borrower’s ability to execute the proposed real estate project successfully. The resultant interest rates reflect the risk assumed by the lender, often manifesting as higher rates than those associated with conventional loans. The expected delta, or difference, between conventional and hard money rates can range from 4% to 10%, contingent on variables like market conditions, property type, and the borrower’s financial standing. While this is a general rule of thumb, their are times when the conventional lenders’ appetite for investment drives them to price closer to hard money options to limit the origination of investment loans.
Concerted Movement with Conventional Rates:
Unlike synchronized dancers, hard money rates and conventional rates often move to different rhythms. We have already established that there is typically a spread between conventional and hard money loans, but the spread is not constant. While they will both more or less follow the broader lending at credit trendlines, they will do so at differing speeds and to different extents.
Conventional rates are intricately linked to broader economic conditions, monetary policy, and market fluctuations, adjusting in response to changes in the Federal Reserve’s interest rates or economic indicators. In contrast, hard money rates exhibit less correlation with these macroeconomic shifts. While influenced to some extent by overall economic conditions, hard money rates remain less susceptible to mirroring the nuanced trends of conventional rates and will generally move at a slower pace. The unique nature of hard money lending insulates it from the intricacies of the broader financial market.
Impact of Federal Reserve Policy:
Addressing the broader financial market, the impact of Federal Reserve policy on hard money rates is notably subdued. Unlike conventional rates that may fluctuate in response to the Federal Reserve adjusting its benchmark interest rates, hard money rates demonstrate a greater degree of independence. The private nature of hard money lending allows it to operate within its sphere, less influenced by the regulatory winds that guide traditional financial institutions. This is not to say that monetary policy has no influence on hard money loans, they do. The impact, however, is more muted and the speed and degree of change is slower and less predictable.
Negotiability of Rates:
Moving on to the negotiability of rates, conventional loans often come with fixed interest rates or rates determined by prevailing market conditions. Additionally, requirements for adherence to fair lending regulations which prohibit lenders from offering different rates for the same deal and credit profile mean that providing any negotiated discounts would imperil the lender and expose them to fines and other penalties. Negotiation room is , and borrowers must adhere to terms set by the lender.
In contrast, hard money loans offer a more negotiable landscape. The private nature of these transactions enables a personalized approach, allowing borrowers and lenders to engage in discussions to tailor interest rates and terms based on the specifics of the deal. This flexibility is a significant advantage for borrowers seeking customized solutions for their unique real estate ventures.
So Which is Better?
In the expansive landscape of real estate financing, a nuanced understanding of hard money rates versus conventional rates is imperative for astute decision-making. While conventional loans offer stability and lower rates, hard money loans provide a lifeline for those navigating unconventional scenarios. The determination of rates, their relationship with conventional rates, the influence of Federal Reserve policy, and the negotiability of rates all contribute to the intricate dance between borrowers and lenders in the diverse world of real estate financing.
Whether traversing the conventional route governed by established norms or venturing down the less-trodden path of hard money, let informed decisions guide your real estate endeavors towards success.