If you have less than perfect credit, you might find it harder to secure a loan. Maybe you even have great credit, but your income is inconsistent. No matter the case, you have options. The most common are subprime mortgages and hard money loans. While they are both for borrowers who don’t qualify for any other type of financing, they have vast differences. We take a look here.
What are Subprime Mortgages?
Subprime mortgages today are known as alternative loans. They are loans provided by a private lender. You won’t find them at your big box banks. Instead, the smaller, local lenders often provide them. They have many similarities to standard loans. You obtain the funds from a bank. In return you promise to pay the specified amount of interest over the life of the loan. The loan may be a fixed or variable rate. It is often offered in varying terms as well.
The one thing subprime loans are known for is their higher interest rates. This is because of the risk they pose. Lenders don’t need perfect credit or even stable income. They often accept bank statements as proof of income rather than paystubs and W-2s. In exchange for this risk, they often charge higher fees and charge higher interest rates.
What are Hard Money Loans?
Hard money loans are loans not from a bank, but a private investor. The lenders do not base the loan amount on your credit, income, or employment. Instead, they focus solely on the value of the property. The term for these loans is often much shorter than a subprime loan. You may find them with terms ranging from 6 months to 5 years. Standard mortgages, on the other hand, usually have terms between 15 and 30 years.
The Pros and Cons of a Subprime Mortgage
The subprime mortgage obtained a bad reputation over the years. Many believe it is one of the largest culprits in the housing industry’s downfall. Today, the loans are making a comeback, though. They are better than ever too. Here we look at the pros and cons of these loans.
- Gives people with less than perfect credit a chance to secure financing to buy a home. The relaxed guidelines make it easier for borrowers to secure the financing they need.
- Gives borrowers a second chance. Not only can they purchase a home, but they can fix their credit. With timely payments, your credit score may increase. This opens up new options for financing in the future.
- Typically allow low down payments making it easier to afford a new home.
- The fees on subprime loans are often higher than other loans. The lender needs to make up for the risk you pose. They often require the fees upfront rather than wrapped into the loan. This helps protect them in the face of default.
- You must still qualify for the loan based on your income. No matter how you verify it, you must show you have the money to cover the new mortgage and your existing debts.
- Subprime loans often have adjustable interest rates. This makes affording the loan in the future more difficult.
The Pros and Cons of Hard Money Loans
Hard money loans have an even worse reputation than subprime loans. They have never made a name for themselves. However, they do have a place helping real estate investors continue to flip houses.
- Hard money loans may have a shorter waiting period. There is not as much paperwork to get done. There also is very little verification necessary. This gives you access to the money you need fast.
- You often have more bargaining power with hard money loans. Lenders are private investors or groups of investors. They have more leeway with what they can waive or change. If you need a lower interest rate to afford the payment, you may have an easier time negotiating it.
- You may even be able to negotiate different types of collateral. If you know the house you want to buy doesn’t have enough value. You can offer a hard money lender other types of collateral, such as another property or your retirement account.
- Hard money loans are expensive. Not only are the fees higher, the interest rate can get pretty high. There are no restrictions on this type of loan. Private lenders can charge whatever they see fit to charge.
- The repayment period is much shorter than a traditional loan. This means higher payments. It also means it could be easier to default on the loan.
- There aren’t many regulations for these types of loans. You don’t have the protection of the Qualified Mortgage Guidelines or the Ability to Repay Rule. You could easily get in over your head.
Subprime loans and hard money loans both have a bad reputation, but they both have good qualities. Before you decide which one is right for you, consider your circumstances. Are you buying a home for yourself to live in? If so, consider subprime loans. They give you a little more protection and a longer repayment period.
If you are buying a home to fix up and sell right away, you may not care about the shorter repayment period of a hard money loan. If your goal is to sell the house in 12 months, you won’t’ have to worry about owing so much money. You can negotiate terms that are favorable to you since you only need the loan for such a short amount of time.
Make sure you compare your options side-by-side. Don’t assume one loan is better than the other. Really look at your options and see what you have to work with. Make sure you determine if you have any bargaining power. Are there things you could negotiate, such as closing costs or the interest rate? Shop around and find the best deal so you can make your home purchase as successful as possible.