Hard Money Vs. Private Money: What’s the Big Difference?

Recently one of our newer investors posed this question to me:

“Hi, I’m a newer investor so I hope you don’t mind the newbie question! I’m trying to figure out how to get the money for my deals. I’ve heard about hard money for real estate and private money, but I’m having a hard time clearly understanding the differences between the two… Could you please explain? Thank you!”
         – Mary Ann Tyson, Scottsdale, AZ

This is a great question and it’s important that every investor understand the differences. I remember what it was like being new to real estate – what you have to learn is just so overwhelming. I hope I can clear up the differences between the two types of lending…

In this post, I’m going to discuss the definitions, advantages, and disadvantages of hard and private money. That way, you are ready to use the appropriate one when a deal pops up.

Hard Money – Always Available – For a Price

Hard money is money that is typically asset based. Asset based means the lender doesn’t care too much about you or your background (although they are starting to care…more about that later), as long as you have some money to put into the project. In other words, you have ‘skin in the game.’

You can always find a hard money lender. Many real estate clubs have lists of lenders for their areas, and there are a ton of them on the Internet. You can also talk to other investors for referrals to these lenders. Hard money lenders typically are in the business of lending money. Although it is good to establish a relationship with these guys, it is definitely not required.

The hard-money lenders do care about what the house is worth and the likelihood of getting their money back if the investor screws things up. They will want the first position on the Deed of Trust, and their total investment will probably not exceed approximately 65% of the after-repaired value of the property.

Prior to the real estate crash of 2007-2008, lenders never looked at your credit or your success as an investor. But many of those hard money lenders got badly burned during those times. Now, they are a little more careful, and you might find them asking to pull your credit. They will want to know more about you before they loan you money.

Hard money is typically short-term financing – 6 months or less – at a very high interest rate. It could be 12% with a bunch of points on the front end, or little to no points up front, but a high interest rate of up to 18-20%.

Private Money – Who’s Your (Sugar) Daddy?

Private money is more of a relationship between you and a ‘financial friend.’ Your friend has lazy money that is sitting around not providing the returns they would like. People who have private money are not typically real estate experts.

Here are some examples of sources for private money:

• Small business owners
• Accountants
• Professionals
• Attorneys
• People who have recently retired
• People with IRAs
• People who have money sitting in banks making poor CD returns
• People who are just sick and tired of dealing with the stock market

Private money friends understand just enough about real estate to know that it can be a good investment, if it’s done right. Those friends also understand that they don’t necessarily have the time or the motivation to purchase real estate themselves.

But they know you. You are the expert in real estate. You present them an opportunity to invest in deals without a lot of work on their part. They know that their money would be secured by the real estate.  Typically, private money will have a first or second Trust Deed position.

You pay them an interest rate that you negotiate with them – usually between 7-15% (but normally around the 10% mark) for first Trust Deed positions. For second Trust Deed positions, it’s typically a little bit more because they’re taking on more risk.

Before you find a deal, sit down with your ‘financial friend.’ Explain to them that you are coming across a bunch of great deals – more than you can ever pay for on your own. You want to give them an opportunity to earn good returns on their money, secured by the real estate. You don’t need their money right at this moment, but at some point in the future you might find a good deal.

You also explain that many of the good deals aren’t around long. The money has to be ready. The reason you are finding deals for such a good price is the fact that you are telling the seller you can move quickly, and pay cash.

Here’s the sequence of events when you find the deal:

1. You find that great deal.
2. You call up your private money guy or gal.
3. You break down the deal for them.
4. You request the money.

With private money you are never personally borrowing the money. Your friend’s money always goes through the closing and is put on the HUD. Your closing agent handles all those funds.

Hard or Private – Which is Right for Me?

Unlike hard money lenders, private money people are not loaning you money – they’re investing in an opportunity. That’s the main difference between the two.

Private money can also be longer-term money. It doesn’t have to be six-month or one-year loans. You can negotiate private money out to three years. You can even negotiate it out to 10years. It’s whatever you and your financial friend negotiate as terms on that money.

Like hard money, private money is asset based. Private money lenders are not really basing their decision on you – it’s just that they trust you. But they aren’t necessarily doing things like running your credit or asking for you to sign a personal guarantee…

But if they do, you should feel comfortable complying. After all, you just hunted down a good deal. You should have enough confidence in that deal to go out and raise money from your financial friend. You should also have enough confidence to put some skin in the game if you need to.

Hard money tends to be more expensive than private money, and hard money lenders will not have programs to finance you for long periods. You will also have to jump through the hoops of their existing program to qualify for the money.

By and large, investors prefer (when possible) private money over hard money for those reasons. However, hard money definitely has its place in your arsenal. It’s a way to get a deal done when you don’t have other options.

Hard money lenders can close very quickly. Private money sources must be nurtured over time. If you don’t have the private money lined up ahead of time, you may have to kiss a great deal goodbye. That is why it is good to ask for private money before you find deals.

Ultimately when it comes down to it, a lot of investors will turn their nose up at hard money because they think, “Why would I want to pay that much?” But if it gets the deal done, even at the last minute, then better to have a deal and pay more money than not have a deal at all.

What You Can Do Now

Think of all your friends, business associates, and acquaintances…

Do any of them fit the profile of a private lender? You may want to start talking to them now about the returns you could offer them. Build up their confidence in you as a real estate investor too. Because ultimately, the private money will flow to people they trust.

As a backup, you may want to start looking at sources of hard money in your area. Sometimes when it rains, it pours. You may suddenly have more good deals than your private money can fund. It’s always good to have a hard money lender in your hip pocket just in case.