Hard money loans share similarities with more conventional loans. For example, borrowers typically make monthly payments over the term of a hard money loan. But what do those payments cover? How are the payments structured compared to more traditional loans like mortgages and car loans?
Not Conventional in Any Way
The first thing to know is that hard money loans are not conventional in any way. They are provided by private lenders; conventional loans come from banks and credit unions. Hard money loans are also private loans, meaning they do not fall under the federal regulations governing how conventional lenders do business.
Hard money can take the form of a traditional-looking conventional loan, with some modifications, or a bridge loan designed to bridge the gap between immediate financial need and a future asset or source of income. With all of that said, it is time to move on to how payments on hard money loans are structured.
Most Common: Interest-Only
Being private lenders gives hard money lenders significantly more flexibility in how they structure their loans. A lender and borrower could work together to create a completely unconventional loan package they both agree on. But that’s not usually how it works.
Actium Partners, a Utah hard money firm based in Salt Lake City, says that the majority of hard money loans are structured as interest-only loans. The interest-only concept is well-known. Here’s how it works in terms of monthly payments:
- Monthly payments cover interest only.
- The payments continue until the end of the term.
- The final payment includes interest and the total principal borrowed.
Back in the 1990s, when interest-only loans were prevalent in residential real estate, the loans were also known as ‘balloon loans’. They were so named because of the balloon payment due in the final month of the term. The payment included both the final interest amount and the principal.
Early Repayment Penalties
Although there are exceptions to the rule, the majority of hard money lenders do not charge penalties for early repayment. Early repayment eliminates existing risk and gives a lender the opportunity to reinvest its money elsewhere.
A More Traditional Payment Structure
The fact that most hard money loans are structured as interest-only loans does not prevent lenders from doing things differently. It is not completely unheard of for hard money to be structured with a more traditional payment model. In other words, monthly payments are split between interest and principal.
Under such a scenario, the borrower would expect to pay more per month. Just as with a conventional loan, interest is calculated on an annual basis. The given amount is divided into twelve and applied to each monthly payment. This does not change regardless of how payments are structured.
If you start with interest and then add an amount to be paid toward the principal, your monthly payment automatically goes up. This could make a hard money loan unaffordable under certain scenarios, which is why lenders tend to avoid doing things this way. They find the interest-only model more attractive.
Be Cognizant of the Details
Hard money lenders have the flexibility to structure their loans as they see fit. While most are structured as interest-only loans, there are other options. What does this mean to borrowers? It means they need to be cognizant of the details before they sign loan deals.
As a borrower, it is your responsibility to know and understand your obligations under the loan contract you sign. Be sure you know how your payments are structured. Be sure you know how much you owe and when it is due.
