The Investor's Guide to Private Loans vs Hard Money Loans

[Joshua Michael Hauman]

If you’ve ever taken a loan from a bank, you know funding can take months and come with headaches. Experienced investors rely on unconventional ways of financing deals. Two methods of this are private money and hard money loans, so what's the difference? How do you know whether private or hard money is the right choice to fund your next project quickly? Which option provides the fastest access to funds? The lowest costs? The highest loan amounts? What are the trade-offs between personalized arrangements and standardized processes?

I break all of it down in this article.

Private money and hard money loans are two common forms of financing used by real estate investors, particularly for short-term purchases and projects like a BRRRR or fix and flip. While they serve similar purposes, there are some key differences between these funding sources that investors should understand as they can be very expensive if not respected properly.

What is Private Money?

Private money loans are provided by individuals the investor knows personally, such as business contacts, friends, or family. The funds come directly from these private parties rather than banks or mortgage companies. Private lenders earn interest on the loan as their return. They may also charge origination fees. These are often known as points or lender fees, more on that later.

Private money allows for highly customized loan terms and conditions since it is based on personal relationships and lenders can set their own criteria. Interest rates, in my experience typically range from 8-20% based on the borrower's profile and the deal specifics. The application and underwriting process is also less stringent compared to traditional lending sources.

What is Hard Money?

Hard money loans come from professional lending companies that specialize in short-term real estate financing. The hard money lender's sole focus is providing bridge loans secured against the property itself rather than the borrower's financial strength. This is often why they are called hard money because the loan is refenced to a hard asset.

Interest rates for hard money loans range from 10-18% with origination fees of 1-3 points. The funds come from the lending company rather than private individuals. Terms and conditions are more standardized than private money since hard money lenders have specific loan programs and guidelines.

Key Differences and Considerations

While private and hard money both provide alternative financing sources, there are some notable differences:

• - Private money involves a personal relationship between borrower and lender. Hard money is strictly a financial transaction.
• - Private money offers more flexibility in loan terms and conditions based on the specific situation. Hard money uses set loan criteria.
• - Private lenders have more variable rates based on the deal. Hard money rates fall within a narrower band.
• - Private lenders focus on both property value and borrower profile. Hard money focuses on asset itself.
• - Private money decisions involve personal trust and mutual understanding. Hard money uses defined lending formulas, primarily the value of the property and specifics of the deal dictates how much risk they are willing to take on and ultimately willing to lend.
• - Private lenders have more discretion on amounts lent. Hard money uses set lending parameters and LTVs (Loan to value).
• - Private money can fund deals banks won't touch. Hard money is still mostly business focused.

Assessing Private vs Hard Money

So how should an investor choose between private and hard money for a real estate project? Here are some key factors to consider:

Available Sources - Which type of financing do you have access to through your current network? Do you have private lenders ready to fund deals? Think of the proverbial rich uncle.

Speed - Hard money can often provide the quickest access to funds. Private lenders may still be faster than banks but lack the dedicated infrastructure of a hard money company.

Costs - Private money interest rates can potentially be negotiated lower than hard money rates due to the personal relationship aspect. But this depends greatly on the specific lenders.

Loan Amount - Private lenders are often willing to provide more sizable loans than hard money firms since decisions involve trust rather than strict lending formulas. This is not always the case but rather a general rule.

Flexibility - Private money allows for more customized arrangements like interest-only payments, extensions, or unique payment structures. Hard money offers standard loan programs.

Lender Requirements - Private lenders focus on both property and borrower. Hard money focuses far less on the borrower and considers real estate asset as the collateral.

Securing Private Money Loans

Private lenders must be cultivated through networking, referrals, and building strong relationships over time. At least that's how I've done it. Tapping into private money funding starts with casting a wide net within your contacts.

Let friends, family, business associates, investors and other networks know you provide attractive returns financing real estate deals. This goes far beyond just asking directly for money. This takes networking, build connections first and fostering trust. A good way I do this is talk about my deals and the framework I use for this is inform and educate.

I wrote a separate article on that framework here:
https://www.biggerpockets.com/forums/62/topics/1141846-how-d...

When networking with private money lenders with the intention of raising capital its important to:

Set clear investment expectations upfront regarding typical returns, timelines, risks, and how you mitigated them. The more professional you appear; the more confidence private lenders will have. All deals have downsides, the more clearly you can articulate these and show you’ve planned for when things go wrong the more trust will be built.

Draft a one-page overview of your experience and accomplishments as a real estate investor. Provide examples of successful projects and returns. This “track record” document establishes credibility.

If its in your investment strategy, give lenders the option to finance specific projects that match their investment goals rather than requiring blanket funds. This creates more flexibility. This is a balance I’ve found of creating one specific offering for one type of investor rather than trying to serve all of them. Focus leads to expertise and scalability.

Follow best practices in legal documentation, reporting, payments and communications. This keeps private lenders satisfied and willing to use you again thus creating stronger relationships and increasing lifetime value.

Obtaining Hard Money Loans

The process for securing a hard money loan is more streamlined than private money in my experience and qualification is focused heavily on the underlying real estate asset.

Step 1: Reach out to hard money lending companies operating in your area or that finance projects nationwide. If your broker or real estate network recommends a provider, start there.

Step 2: Research lenders’ requirements, experience, and preferred project types. Different lenders prefer different deals. By asking them what deals they typically take on and what projects they have done most recently you can match up the appropriate debt to the asset type. Target those that fit your current profile and needs.

Step 3: Prepare key documents upfront for pre-qualification including a summary of the project, comps and valuation estimate, scope of work and budget, and exit strategy. I would underwrite the deal as a flip and a BRRRR. You wont want to hold onto that expensive money for long. You need a strong exit strategy and more options can save you if things don't turn out as expected.

Step 4: Be ready to move quickly providing due diligence like purchase contracts, appraisal, insurance documentation, and any other collateral. It’s best practice to have an attorney review loan documents and understand the risks and costs associated with hard money financing.

Which Loan is Right for You?

It all starts with the deal. Analyze the amount required, collateral available, your risk tolerance, and expected project timeline. Weigh the benefits and limitations of both private and hard money. For new investors with fewer assets, tapping personal contacts for private money may be the most accessible starting point. It provides more room for error through personalized arrangements or even partnerships with more seasoned professionals. Experienced investors flipping houses or doing renovations may prefer the speed and standardized processes of hard money lending companies. Either way its a premium worth paying if you find the right deal.

I use a mix of both financing sources and found that provides the most flexibility based on the situation I’m in. Overall the best option depends on your specific financing needs, profile, real estate niche and unique circumstances. For larger customized loans with flexible structures, private money has advantages. For urgent capital on strict business terms, hard money may be preferable.

With Discipline,

Josh