Why Soft Money Fails in Hard Times

by | Nov 1, 2023 | Financing and Loans


  • Soft money lenders make revenue by selling their notes to institutional buyers;
  • Soft money interest rates are lucrative and feasible only when the market is stable or predictable;
  • When markets change, soft money lenders fall apart or raise their interests on their borrowers;
  • Hard money is privately funded and does not rely on institutional buyers;
  • Hard money lenders have higher interest rates in part to create a stable lending base, whether the economy is volatile or the real estate market is stable;
  • With all the extra hoops you have to jump through to get a soft money loan, and the risks of losing the lender when times are unpredictable, it is worth considering the advantages of a hard money loan.

Soft Money vs. Hard Money

It happens to many real estate investors, both beginners and veterans: in the hard money vs. soft money dichotomy, the choice is often made for soft money because of its typically lower interest rates. Few understand the intricacies that make soft money a high-risk, high-reward play. Not until times of economic uncertainty does the problematic nature of soft money become apparent. In fact, it is for the short-comings of soft money lenders that hard money lenders were established as legitimate, competitive, and, oftentimes, better alternatives in the first place.

Soft Money Means Unstable Money

Soft money lenders are set up to make profits by selling their notes to institutional buyers, typically a hedge fund or corporation or loan shark. For example, a soft money lender funds a loan for a 6% interest rate. It then turns around and sells that loan to an institutional buyer at a 12% interest rate, creating a 6% margin of revenue. Because soft money loan terms can typically span up to 30 years, to make revenue on this business model soft money lenders essentially have to make a numbers play: the more notes they generate, the more revenue they accrue. The end game for many soft money lenders is to acquire a large quantity of loans to then sell their business as a whole to an institutional buyer. Either way, in the long run, soft money lenders are not supporting their loans and are looking for a way out of supporting their borrowers.

Soft Money’s Hidden Risk

The quantity play of the soft money industry works as long as the economy is stable or predictable. At a 6% margin of revenue at best, when the economy shifts, the borrowers pay for it. You don’t have to use your imagination to see how this happens. As the real estate market in the Puget Sound region shifted and the Fed raised the interest rates, soft money lenders focused on growing their note quantity and had deals they funded in the previous one to two months that didn’t pan out based on their expected LTV. That means they had to close draw accounts and call their loans due–something that does not happen to hard money lenders.

With low interest rates and long loan terms, there is no margin for error. A loan funded three weeks ago based on a 6% interest rate for an expected LTV of 65% becomes unprofitable when real estate values shift and the LTV now sits closer to 70% to 80%. Typically what happens in these scenarios is soft money lenders will eat the difference for a few weeks. Some lenders even refuse to pay out any remaining construction draw balance and call their loans due. But inevitably their rates will increase, and, as when the COVID pandemic began, many soft money lenders will not lend until the market restabilizes, leaving investors looking for new lenders.  In unstable times, even if you are a veteran real estate investor, a soft money lender cannot lock an interest rate on a loan for you nor can they tell you what loan rates will be within a two week period. Because they essentially act as a liaison for institutions, your money and their support is not guaranteed. As soon as the economy destabilizes, they have to raise their rates to make-up for lost revenue and continue to sell to institutional buyers at a similar rate, or they have to cease lending altogether. Either way, soft money lenders, marketed as a long-term solution for real estate investment, are only as stable as a short-term view of the market.

How Hard Money is Different

Hard money is reliable in unpredictable markets and periods of relative economic instability. Unlike soft money lenders, hard money lenders are backed by private capital, which means they don’t rely on selling notes for generating revenue. Consequently institutional buyers, whether they’re trying to buy notes or not, do not change the nature of hard money loans. Because hard money lenders like Intrust Funding are funded with private capital, whenever Fed interest rates change, or when the housing market fluctuates wildly, it does not affect loan interest rates. With private investors providing capital for true hard money lenders like Intrust Funding, the risks for borrowers of having out-of-state institutions who are not connected to the local market don’t exist. Fluctuations scare institutional buyers, but not local investors. Intrust Funding has close relationships with our investors, guaranteeing reliability and stability for all our borrowers. 

Is Soft Money Worth It?

The bottom line with soft money is that the further away the investor is from the fund, the less stable the lender is. Although the money is cheaper, it’s also less stable. Because soft money lenders use institutional buyers, their business shares the ups and downs of the economy and, often, crashes when the economy does. There is also the question of all the hassle of taking out a loan with soft money lenders. Borrowers have to acquire appraisals (or BPOs) typically two days before they’re supposed to close. The appraisal causes trouble for some borrowers. Say, for example, a soft money lender estimates their interest rate and funding amount based on an appraisal of $700k. Say the appraisals come back at $610k. In this case, borrowers have to run around to find $90k more to put down on their loan. At Intrust Funding, we require no appraisals, we base your loan on the ARV (after repair value) of the investment property, and we can fund your deal within 48 hours of qualifying.  For your next real estate investment deal, prequalify today to partner with the most simple, efficient, and reliable lenders in the industry!

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