Hard Money Loans vs. Rent Payments
Private loans, sometimes referred to as “hard money” loans sometimes get a bad rap. Perhaps it’s just the name “hard money” that shades the reputation but the fact is that private money plays an extremely important part when financing real estate. However, hard money can also refer to loans that don’t fit into the Qualified Mortgage status, or QM. Such loans have certain features that leave them outside the QM category but that doesn’t automatically mean the loan is bad for the consumer. On the contrary, a private loan or non-QM mortgage can be the perfect fit under the right circumstances. There is a proper place for such loans.
One of the qualifications is for the loan to be completely amortized over the life of the loan. A loan fully amortizes when each monthly payment contains both an amount of interest due the lender and another portion to pay down the loan balance. Over the predetermined loan term, the loan will be paid off when making regular payments. However, there are loans that only ask for the interest to be paid each month and a payment toward principal is an option. This is how “interest only” loans work. The borrower has a choice to pay interest only, which means a much lower monthly payment early into the term of the loan or pay the fully amortized amount. It’s completely up to the borrower as well as the terms of the note. But is that a benefit to the borrower? What about renting a property and paying rent, are there differences and if so, what are the they?
Rent payments can also be lower compared to a regular mortgage payment in many instances just like an interest only loan but the primary difference is who owns the property being rented or financed? When renting, the renter has no ownership interest at all. It’s the landlord who benefits because the landlord not only owns the property but if the rental unit is being financed the tenants are in essence paying the mortgages, taxes, insurance and maintenance costs. Real estate investors know that a profitable rental unit must also be able to command enough rent to not only pay for these expenses but to provide a nice monthly profit at the same time.
With regard to a hard money loan to finance real estate, typically an interest only payment is the minimum payment required. The borrowers can certainly pay on the principal if they so choose but it’s not necessary, at least for a predetermined period of time during the initial years of the loan. But the main difference between a hard money interest only loan and paying rent, while both may be lower compared to a regular mortgage payment, the interest only borrower actually owns the property. The renter does not. The borrower with the interest only loan is paying mortgage interest which for most people is a tax deductible item each calendar year. Rent payments are not. While both options provide a better cash flow, an interest only, private money loan is hands-down the better option.