What Is the Difference Between Hard Money and Cash?
Editor's Note: This post was originally published in October 2021 and has been completely revamped and updated for accuracy and comprehensiveness.
The real estate industry is ripe with investment opportunities for property investors. Many of these have a cash-only requirement that gives rise to one of the most common questions in the industry—what's the difference between hard money and cash?
How to purchase investment properties largely depends on your financial situation and is often a matter of personal preference. Some investors prefer to finance with a hard money loan and leverage money to be used elsewhere, including funding additional properties, and some prefer cash transactions.
Read on as we examine the differences between financing your real estate investments using hard money and cash and the pros and cons of both financing strategies.
Is hard money considered equivalent to cash?
Over the past few years, housing shortages have meant competition in the market—paying cash sets you apart from other bidders. In real estate, it's also not uncommon to see investment opportunities that state "cash-only ." And it's almost guaranteed that you'll come across a hot deal that you need to snatch up quickly, and you won't have the time to jump through the hurdles of traditional financing.
Scenarios like these are some driving forces behind a common question in our industry—is a hard money loan considered cash or not? The confusion is understandable.
Cash implies a certain amount of money that you already have in your possession. In contrast, a loan means you're using borrowed funds because you either don't have cash or choose not to use it.
Like any other loan, hard money loans are subject to approval, inspection, appraisal, etc. Cash always has the power to close, and there is no risk that the funding will fall through—thus, the phrase "cash is king." Also, sellers who demand cash only may not agree to hard money financing.
So, we've established that a hard money loan is not cash, but there are instances when the two are considered comparable. For example, cash and hard money both allow real estate investors to close deals quickly. Because hard money loans have shorter processing times than traditional loans, real estate investors can move on opportunities rapidly. In fact, hard money loans can be funded within a few days.
Banks and credit unions must review your credit history, employment history and personal income before qualifying you for a loan. Hard money loans, however, consider the property's value, so as soon as the lender can be sure that your property's valuation is accurate, they are ready to offer a loan.
As an investor, your goal is to purchase a property with a significant upside. The dollar spread between your hard money loan (the post-repair property value), and the current market value represents the anticipated profit on your investment. For this reason, a hard money loan is often considered equivalent to cash in real estate investments.
Hard money vs. cash for common investment strategies
Fix and flip investing
Fix-and-flip is the strategy of purchasing a property—typically a distressed one—at a discount, renovating it, then selling it for a profit. Like cash offers, hard money lending provides fix-and-flip investors with the funding needed to close a deal quickly.
Another way hard money and cash could be seen as equivalent for a fix-and-flip investor is that both options allow them to go after distressed properties at a discounted price. Traditional lenders like banks and credit unions typically don't offer loans for distressed properties.
Hard money has the upper hand on cash for a house flipper because of the leverage, power and agility that come with it. Leveraging means using other people's money for investment. Although there is a risk to financing a purchase, investors free up their own money to purchase more properties.
Also, property owners can increase their returns on the cash invested much more quicker on a financed purchase. So, by paying cash rather than leveraging, investors lose out on the ability to make other people's money work for them.
Buy and hold investing
Though there are many pros to purchasing a rental property with all cash, there is always a flipside. Investors must take a hard look at their finances, investment goals, and the potential of the property they are considering. In some instances, financing may be a better choice.
One downside to purchasing rental properties using your cash reserves is that it can lower your cash-on-cash return—the return you see on the money you invest. If you buy a rental property with all cash, the cash-on-cash return is much lower because you have invested much of your own money into the property. The same cash flow you receive each month from your tenant will see a higher rate of return if you initially invest a fraction of what the property would have cost to purchase with cash.
Using all cash to purchase rental properties can reduce your buying power, making it difficult to scale your portfolio. Financing multiple rentals can be incredibly beneficial. For example, cash flow increases because, as a landlord, you receive monthly rent payments from multiple tenants. As a result, equity paydown and tax benefits increase because they apply to multiple properties instead of just one. Additionally, your net worth increases if you purchase below market value, and diversification creates a safety net of income should something happen to one property.
Using long-term hard money loans as a buy-and-hold investor can also work to your advantage at tax time. Any money owners pay in interest towards a financed rental can be deducted against the property's income. Simply put, real estate investors may not have much tax liability at year's end after all deductions. Be sure to seek advice from a certified tax professional to comply with all tax laws.
Just like with fix-and-flip investing, leverage power is a consideration. Although there is a risk to financing a purchase, you can free up your own money to purchase more properties. In addition, you can increase your returns on the cash invested much more quicker on a financed purchase. So, by paying cash rather than leveraging, you lose out on the ability to make other people's money work for you.
Pros and cons of hard money
- Faster approval process
- Approval is based on property, not credit history
- More flexible terms and loan options
- Less strict underwriting
- The opportunity to rehab distressed properties
- Higher interest rates
- Often require larger down payments and upfront costs like higher origination fees and closing costs
- Shorter terms mean less time to repay
- The lender can initiate a foreclosure on the property if you don't repay the loan within the given time frame
Pros and cons of cash
- No interest payments
- Fewer properties to manage
- 100% equity
- Immediate cash flow
- Reduced buying power
- No leverage power
- Less liquid cash on hand
- Fewer tax benefits
- Lower cash-on-cash returns
While hard money loans are not cash, they are often considered cash equivalent because they differ from traditional loans. A bank will provide you with a mortgage based on the market value of the acquired property (i.e., the purchase price). A hard money loan, however, is based on the expected future value of a property after renovation—not its current market value. These key differences allow you to close deals much quicker—just like cash.
Make sure you have reviewed all available options before making a decision. Understanding the pros and cons of hard money loans and cash transactions can help you identify the right investment choice.