What is the Difference Between Hard Money and Debt Financing?

People looking to passively invest in real estate have numerous options for doing so. Two of them are hard money lending and debt financing. Both represent an opportunity to make a very solid return. Likewise, both forms of passive investing allow investors to build substantial wealth over the long term. Needless to say, they are not the same thing.

If you are looking to get into passive real estate investing, hard money lending and debt financing are just two vehicles for doing so. You could also invest in real estate investment trusts (REITs) and mutual funds that specialize in real estate. You could purchase properties and then turn them over to a property management company. You could invest in property development and then sell the developed properties.

Hard Money Lending

Hard money represents the quintessential tool for passively investing in real estate. As a hard money lender, you are loaning out your own financial resources in exchange for some sort of return. Hard money doesn’t have to go exclusively to real estate, though much of it does.

Actium Partners is a Salt Lake City, UT hard money firm that specializes in real estate. They explain that their position, as an investor, is a passive one. They do not take ownership of the properties they fund. Rather, the role they play is similar to that of a bank.

Hard money lenders require borrowers to put a certain percentage down. They loan based on predetermined loan-to-value (LTV) ratios. Most importantly, their loans are always short term. Up to three years is possible, but lenders try to keep terms to one year or less when they can. They also require assets as collateral.

Debt Financing

Debt financing is a fairly broad term that covers a number of different lending scenarios. In terms of passive property investing, debt financing is nothing more than carrying a loan for someone looking to purchase property. The big difference between debt financing and hard money is that the investor actually owns the property being financed.

Let us say you own a piece of commercial real estate consisting of several retail buildings and some office space. You might decide to sell that property to an investor. Perhaps you would require a 30% down payment. You finance the remaining balance yourself.

If you are smart, you will utilize a standard amortization schedule in order to ensure you earn enough interest to make debt financing worth your while. You establish a payment schedule and then hold your borrower to it. If the borrower defaults, you take control of the property and either sell it or add it back into your portfolio.

Both Are Risky

Hard money lending and debt financing are capable of generating healthy returns in the real estate market. But with those hefty returns comes substantial risk. Any type of investment involves risk to some degree, but the risk is substantially higher in real estate because the amounts being invested are so much higher.

As a hard money lender or debt financier, you could be putting hundreds of thousands of dollars at risk with every deal. That means you could also face substantial financial loss in the event of default. That is why hard money lenders and debt financiers are so meticulous and careful. They go to great lengths to protect themselves – as they should.

Now you know the difference between hard money and debt financing in the real estate investment world. Does either one interest you? If so, go for it. Otherwise, there are other ways to passively invest in real estate without taking on so much risk.