Hard money is a topic not a lot of people are well-versed in. As such, there is plenty of confusion surrounding it. For example, how often have you read blog posts warning to stay away from hard money because interest rates are too high? Unfortunately, a lot of people pass judgment on hard money without looking into the details.
This post discusses some of the details relating to hard money and interest. It is important to understand them if you plan to apply for a loan for your business. You will be pleasantly surprised to learn that the interest question is not as scary as some make it out to be.
Here are the top three things you need to know about hard money and interest, compliments of Salt Lake City’s Actium Partners:
1. Interest-Only Is an Option
Among the many advantages of hard money is the fact that lenders and borrowers can work out nearly any terms that are acceptable to them. For example, structuring a hard money loan as an interest-only loan is an option. What would such a loan look like?
Interest-only loans require monthly payments to cover the interest. A borrower does not pay the principal until the loan’s maturity date. This sort of arrangement is sometimes referred to as a balloon payment. It takes the name from the fact that the final payment is so much bigger the monthly payments preceding it.
Hard money lenders may choose to write interest-only loans. They might also choose to write loans that do not incur monthly payments. They simply lend money with the expectation that the borrower will pay it back on the maturity date.
2. Interest Rates Are Higher
It is true that interest rates on hard money loans tend to be higher. There is good reason for this. Interest is that which enables a lender to make money. The longer the term, the more money the lender stands to make. The problem lenders face with hard money is that said loans are short-term loans. Lenders lend for one to three years as opposed to 10 to 30 years.
Higher interest rates make it possible for hard money lenders to cover their margins. They charge slightly more interest but turn over their money faster. This combination generates the required profits to stay in business.
3. Higher Rates Don’t Equal Higher Payments
This last point is the most critical of all: higher interest rates do not mean higher interest payments. It is important to remember that interest rates are based on an annual computation. For example, a bank loan at a rate of 12% dictates that you pay 12% on the outstanding principal every year. You end up paying 1% per month.
Now, consider taking a hard money loan for $100,000 at 12%. The term is one year. You will pay $12,000 in interest. Pretty easy, right? Now assume that same loan with a 10-year term. Because your interest is recalculated at the start of every year, you will actually pay a total of $79,000 in interest over 10 years.
Let us drop the interest rate to 6%, just to make it fair. Even cutting the interest rate in half doesn’t help. You are still paying more than $32,000 in interest by carrying a loan for 10 years. The fact is that higher rates do not equal higher payments. Loan terms are a much bigger factor.
Now you know the three most important things about hard money and interest. If you didn’t know these things before, you are a more informed borrower for reading this post.
