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Hard Money Loans vs Conventional Mortgages: Understanding the Difference and Navigating Credit Challenges
Introduction
When it comes to obtaining a loan, there are two primary options for borrowers: hard money loans and conventional mortgages. Hard money loans are typically offered by private investors and are secured by real estate, while conventional mortgages are issued by banks and other financial institutions.
Both types of loans have their own benefits and drawbacks, and borrowers must carefully weigh their options before choosing the best one for their needs. In this blog, we will delve into the differences between hard money loans and conventional mortgages, and explore the specific challenges and factors that borrowers need to consider when applying for each one.
Benefits of Each Loan Type
One of the main advantages of hard money loans is that they are more accessible than conventional mortgages, as they are usually offered by private investors with less strict lending criteria. They also tend to have quicker application processes and shorter loan terms, which means borrowers can obtain funding more quickly and pay off their loans faster.
On the other hand, conventional mortgages offer more flexibility and stability than hard money loans. They typically have longer repayment terms and lower interest rates, which means borrowers can make smaller payments over a longer period of time without having to worry about balloon payments or high interest rates.
Challenges that Impact a Borrower’s Credit Score
Late payments
Late payments are one of the biggest challenges that can impact a borrower’s credit score. This is true for both hard money loans and conventional mortgages. Late payments not only result in late fees and penalties, but they also damage a borrower’s credit score and make it harder to obtain future loans. Late payments are usually reported to credit bureaus after 30 days of being past due, and can stay on a borrower’s credit report for up to seven years.
Charge-offs
If a borrower stops making payments on a loan altogether, the lender may charge off the debt and report it to credit bureaus as a loss. This can have a major impact on the borrower’s credit score, as charge-offs can stay on their credit report for up to seven years. Charge-offs can also make it much more difficult for borrowers to obtain future loans, as lenders are unlikely to want to take on the risk of working with someone who has a history of not repaying debts.
Bankruptcies
Bankruptcies are a last resort for borrowers who are unable to repay their debts. While they can provide immediate relief from debt obligations, they also have long-lasting consequences on a borrower’s credit score. Bankruptcies can stay on a credit report for up to ten years, and can make it much harder for borrowers to obtain new loans or credit lines in the future.
Important Factors to Consider When Applying for Each Loan
Income and Employment
When applying for a loan, lenders will look at a borrower’s income and employment history to determine whether they are a good candidate for a loan. This is true for both hard money loans and conventional mortgages. Borrowers who have stable employment and a consistent income stream are more likely to be approved for loans, while those who are self-employed or have irregular income streams may face more scrutiny.
Credit Score and History
Credit score and credit history are also important factors that lenders consider when evaluating a loan application. For conventional mortgages, lenders typically prefer borrowers with higher credit scores and clean credit histories, as these borrowers are considered less risky. Hard money lenders tend to be more lenient when it comes to credit scores, as their loans are secured by real estate, but borrowers with low credit scores or a history of delinquencies may face higher interest rates or other penalties.
Collateral
Collateral is the asset that a borrower pledges to secure a loan. For hard money loans, collateral is typically real estate, while conventional mortgages also require collateral in the form of the property being purchased. Lenders look at the value of collateral when evaluating loan applications, as this helps them determine whether they will be able to recoup their losses if the borrower defaults on the loan.
Unexpected Considerations
Rates on Hard Money Loans
Hard money loans tend to have higher interest rates than conventional mortgages, due to the increased risk that lenders take on by working with borrowers with lower credit scores or less stable finances. Borrowers should be aware of these high rates, as they can significantly impact the total cost of the loan over its lifetime.
Penalties Associated with Hard Money Loans
Hard money loans often come with higher penalties and fees than conventional mortgages. These can include prepayment penalties, late payment fees, and other charges that are designed to protect lenders from the increased risk of these loans. Borrowers should carefully review the terms of the loan to understand these penalties and ensure they are prepared to manage them if necessary.
Closing Thoughts
Both hard money loans and conventional mortgages offer unique benefits and challenges for borrowers. By understanding the specific factors that impact credit scores and loan eligibility, borrowers can choose the loan type that best fits their needs and work to overcome any credit challenges that arise during the application process.
For borrowers with poor credit or irregular employment, hard money loans can provide the funding they need without the stringent lending criteria of conventional mortgages. However, these loans come with higher interest rates and penalties, and borrowers should be aware of the total cost of the loan before committing to it. Borrowers with good credit and stable incomes may prefer the lower interest rates and longer repayment terms of conventional mortgages, but they should also be prepared to undergo more rigorous evaluation during the loan application process.