What differentiates hard money lenders from bank lenders?

Hard money lenders differ from bank lenders in that they often fund more quickly, with fewer requirements. Hard money lenders are sometimes called “asset-based lenders” because they focus mostly on the collateral for the loan, whereas banks require both strong collateral and usually excellent credit and cash flow from the borrower.

Hard money lenders are willing to foreclose on and “take back” the underlying property if necessary, to satisfy the loan. Bank lenders typically look at the borrower to be able to pay back the underlying loan from the borrower’s income, whereas hard money lenders are comfortable looking to a sale or refinance of the property as the method of repayment.

When does it make sense for developers to use a hard money loan?

In our experience, even investors/developers with strong financial statements and access to bank credit frequently choose to use private money loans (also called “hard money loans”). Situations where private money loans make the most sense include those where the borrower:

Requires a quick closing and banks cannot meet the deadline;

• Has more good opportunities than cash;
• Wants to avoid spending too much time raising equity or debt from many different smaller investors, but prefers to instead focus on finding new opportunities;
• Lacks the patience or time to deal with¬†the bureaucracy¬†of securing a loan from a bank;
• Has an excellent investment opportunity, but does not have sufficient financial strength to get a bank loan, and/or;
• Has a bank line of credit but needs a larger loan than is allowed under the existing bank line.

The common theme is that there is an opportunity for the borrower to generate substantial profit (or savings) quickly, and the cost of interest and origination fees is small relative to the anticipated profit, even given the higher interest rates charged by private lenders versus banks.

What are advantages of hard money lenders?

Hard money loans can have a number of advantages over traditional bank financing including:

• A simpler application process and quicker approval/disapproval decision;
• Less scrutiny of the borrower’s personal financial situation, including income and historical tax returns, compared to bank loans;
• Borrowers can allocate less time to seeking financing and instead concentrate on other business;
• Borrowers can avoid the humiliation of being rejected by a bank;
• Most hard money lenders do not expect perfect credit and substantial amounts of disposable income from borrowers, but instead focus on the merits of the specific deal under consideration;
• Self-employment is not seen as unacceptable to private lenders, whereas many banks view self-employment negatively and strongly prefer lending to professionals with very steady income.

What are some disadvantages of hard money lenders?

Disadvantages of seeking a hard money loan may include:

• Hard money loans are more expensive than bank loans, with higher interest rates and origination fees;
• The quality of hard money lenders varies substantially from one lender to another; some are unscrupulous and may be seeking to have the borrower default in order to foreclose on underlying real estate as a business strategy;
• Some lenders may collect non-refundable deposits without having the capital required to make the loan; they may either hope to find the capital once the loan is “tied up” or in rare cases, they may simply aim to collect the deposit with no intention of funding the loan.

What kinds of property do hard money lenders lend on?

Hard money lenders will lend on both commercial and residential properties, although many will not lend on owner-occupied residences due to higher thresholds of scrutiny required by law. Commercial properties can include industrial, shopping centers, and office buildings. Some, but not all, hard money lenders will also invest in raw land slated for development and even hotels.

Vacation homes (single family residences), even if not a primary residence, are considered “owner occupied” and may or may not be financeable depending on the lender’s criteria regarding owner-occupied home loans.

 DOCUMENTATION AND TERMS & CONDITIONS

What documents are involved in a hard money loan?

Typical loan documents required for a hard money loan include a Note and a Deed of Trust; other documentation requirements do vary but may include a personal guarantee from borrower (sometimes non-recourse loans are issued without a personal guarantee); personal financial statements such as past tax returns and proof of income; and assurance that the borrower has access to sufficient cash to perform any and all proposed property renovations.

How much do hard money lenders charge?

Hard money lenders typically will charge interest rates in the high single digits to low double digits, with a range of 7.5 percent to 12 percent being considered standard. Additionally, origination fees can range from 1-3 points, with any additional points above this range usually signaling that there are numerous brokers involved in the transaction. It should be noted that points paid on a longer-term loan may be beneficial if the borrower needs capital for a longer period of time, as it is not uncommon for many hard money lenders to include pre-payment penalties which guarantee the lender a minimum number of months of interest on the loan principal.

Borrowers should also be aware that extension options are possible on hard money loans and are a matter of negotiation with a lender.

What are typical hard money lenders terms?

The typical term for a hard money loan is 6 months to 3 years. Loans requiring greater than a 3-year maturity are usually outside the scope of this form of financing.

Single family home renovations would tend to be 6-12 months in duration, while a commercial shopping center renovation term would likely be 2-3 years.

Hard money loans often require a personal guarantee and require first positioning as the lender of record, although some lenders are willing to make subordinate junior loans where another lender holds the primary mortgage.

What happens if a borrower doesn't pay the hard money lenders back?

A borrower who defaults on a hard money loan ultimately is subject to having the lender foreclose on the property which has been put up for collateral. It should be noted that lenders typically follow a sequence of steps in order to try to avoid this final recourse. Such steps may include the lender attempting to reach the borrower to find out the current status and disposition of the property in order to see if things can be worked out cordially; the penultimate step is to file a Notice of Default if necessary to trigger the legal foreclosure process.

What due diligence information do hard money lenders require?

Hard money lenders have different requirements for the due diligence process, but generally speaking, origination of commercial loans will require the most comprehensive list.

Residential loans may require an appraisal from an outside party; a property inspection report; a geology inspection (particularly based on the locale of the structure); and the borrower’s financial records. An in-person inspection of the property is nearly always part of the decision-making process, which is why hard money lenders tend to have a localized focus.

WHAT IS TRUST DEED INVESTING AND HOW IS IT RELATED?

What is trust deed investing?

Trust deed investing is simply investing in loans secured by real estate. Most trust deed investments are relatively short term loans (maturity under five years, with many loans two years or less) made to professional real estate investors. In the current economic climate professional real estate investors are buying properties needing¬† a substantial renovation, fixing-up these properties, and reselling them for a profit. Banks are reluctant to lend to this market not because the loans are particularly risky, but because banks have taken write-offs on real estate loans and are still wary of originating new real estate loans, other than the most “plain vanilla” loans.