Buying an Investment Property: Conforming Financing vs a Hard Money Loan in California

Published on March 21, 2017

– 9 min read

Investing in real estate can be one path to building wealth, but it takes a certain amount of money to get started.

If you’re buying an investment property in California, you may be exploring two different financing options: conforming financing or a hard money loan. Understanding the difference between the two is essential. You may be familiar with conforming financing, but you might be asking yourself – what is a hard money loan?

First things first: Conforming financing

Conforming loans are only for residential properties. There are two types of conforming financing options when buying an investment property, which depend on how and whether you intend to occupy the property:

  1. Owner-occupied properties – where you live in one of the units of a multi-unit property for at least for 1 full year.
  2. Non-owner-occupied properties – also called investment properties, where you do not live in the property or any of its units.

Generally, for a property to be classified as multi-unit, each unit must have its own entrance, kitchen, bathroom and utility meter. Clara currently offers financing for owner-occupied and non-owner-occupied properties with 1 to 4 units located in California. On a broader scale, you can also obtain conventional mortgages for investment properties through banks and credit unions.

The maximum loan amount for a conforming investment property is just above $1.2M for a 4-unit property in high balance counties in the contiguous US and District of Columbia. In Alaska, Hawaii and some US territories, it’s as high as $1.8M. To see loan limits for the 1, 2, and 3 unit investment properties for conforming mortgages, check out these guidelines.

The minimum down payment requirements vary based on the number of units, whether you’re going to live in the property, and if you’ll do a fixed-rate or adjustable rate mortgage (ARM).

If you’re going to live in the property with a fixed-rate mortgage:

  • 2 units – minimum down payment = 15%
  • 3-4 units – minimum down payment = 25%

If you’re going to live in the property with a adjustable-rate mortgage:

  • 2 units – minimum down payment = 25%
  • 3-4 units – minimum down payment = 35%

If you’re not going to live in the property:

  • 1 unit, FIXED – minimum down payment = 15%
  • 1 unit, ARM – minimum down payment = 25%
  • 2-4 units, FIXED – minimum down payment = 25%
  • 2-4 units, ARM – minimum down payment = 35%

To get a conforming mortgage, whether you live in the property or not, in addition to meeting the down payment requirements, you’ll have to meet the credit criteria of lenders. For example, some lenders won’t lend if your credit score is lower than 620 or if you’ve had a foreclosure in the last 4 years.

If you’re not able to meet the down payment or credit criteria for conforming financing, don’t fret — you still have options.

What Is a Hard Money Loan?

A hard money loan is a type of financing that’s secured by an asset, usually real estate, such as an investment property. Hard money loans are relevant if you’re buying an investment property because they are typically designed to meet investors’ short-term financing needs.

While some hard money lenders will offer loans for owner-occupied properties, hard money loans are most often designed for investment properties that you don’t plan to live in. That could be something small, such as a duplex or triplex, or something larger, like a 30-unit apartment building. Hard money loans can also be utilized to purchase residential properties for fix and flip projects. RealtyShares, for example, is a California hard money lender that offers non-owner occupied financing to real estate investors for both residential and commercial properties.

Comparing Conforming Financing to Hard Money Lending

When buying an investment property in California, it’s important to note that hard money loans differ from conforming financing in several ways. First is the way hard money loans are structured, compared to conforming financing.

For instance, Clara’s mortgage offerings include 15-, 20-, 25- and 30-year loan terms, as well as several ARM options – 3/1, 5/1 and 7/1. If you’re choosing a conventional loan structure with a fixed rate, your loan payments would remain level over the life of the loan. If you choose an ARM, it’s fixed for the entry period and then adjusts based on market conditions for the remainder of the term (usually 30 years in total).

Hard money loans, on the other hand, generally operate on a shorter timeline. Depending on how the loan is structured, the loan term may not exceed 12 months. Some hard money lenders may offer terms of up to five years. Rather than making level payments, you might make interest-only payments, with one large balloon payment required at the end of the term.

The difference between conforming loans and hard money loans is also apparent where the down payment is concerned.

With hard money financing, the amount of money you’re expected to bring to the table is tied to the property’s loan-to-value ratio. This is the ratio between what you’re hoping to borrow and the property’s appraised value. Only rarely do hard money lenders offer 100% financing; more often, you’re required to have between 10% and 50% for a down payment. You can pay this money out of pocket or use alternative financing, such as a mezzanine loan to come up with the cash.

Hard money loans may also feature higher interest rates than conventional financing. Conforming mortgage rates are near historic lows (~4%), so even with some recent rises they don’t come close to the rates that some hard money lenders charge. It’s not uncommon for investors to pay between 7% and 14% for a hard money loan.

There is a trade-off, however, with respect to two things: credit qualifications and speed. With a hard money loan, lenders are more interested in the quality of the property, than a credit score. What they’re trying to assess is how likely you are to be able to repay the loan based on how profitable the property appears to be, not necessarily how stellar your credit history is.

If you’re applying for conventional financing, you must meet certain credit criteria — usually above 620 FICO without a foreclosure in the last 4 years or bankruptcy in the last 7 years. Having previous experience as a rental property owner may work in your favor, but if you have serious delinquencies, a recent foreclosure or a bankruptcy on your credit history, that may be a stumbling block to approval.

Another positive associated with hard money loans is funding speed. It’s possible to have cash in hand to purchase an investment property in as little as a week. With conforming financing, you legally cannot close in fewer than 7 days. The industry average on a conforming purchase loans is about 45 days, but Clara can do them faster. If you have a specific timetable, just let us know!

Which One Is Right for Investors?

There’s no one way to answer this question; both conforming financing and hard money lending have advantages and disadvantages when buying an investment property. Deciding which one to pursue all comes down to how you plan to approach your investment.

For instance, if you’re buying an investment property and don’t plan to live in the home, that eliminates owner-occupied financing right off the bat. If you can’t meet the minimum down payment or credit criteria of a non-owner occupied conforming loan, then that’s out too. Hard money lending may be the best choice under those circumstance or if you need to move very quickly.

Ultimately, you have to consider all the variables of the investment before making a final decision. Choosing the wrong type of financing could put a damper on your ability to reach your investment goals so it pays to do your research well in advance.

If you’d like to see what our rates are for investment properties you can do so easily online in about 3 minutes here or chat with one of our licensed Loan Specialists.

Jack Grace
Jack Grace is a licensed Loan Specialist at Clara. Outside the mortgage world, you’ll find him at a Giants game in San Francisco, at the beach, or exploring the Bay Area with his dog, Lucy.
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