Hard Money Loans
A hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by the value of a parcel of real estate. Hard money loans are typically issued at much higher interest rates than conventional commercial or residential property loans and are almost never issued by a commercial bank or other deposit institution. Hard money is similar to a bridge loan, which usually has similar criteria for lending as well as cost to the borrowers. The primary difference is that a bridge loan often refers to a commercial property or investment property that may be in transition and does not yet qualify for traditional financing, whereas hard money often refers to not only an asset-based loan with a high interest rate, but possibly a distressed financial situation, such as arrears on the existing mortgage, or where bankruptcy and foreclosure proceedings are occurring. Many hard money mortgages are made by private investors, generally in their local areas. Usually the credit score of the borrower is not important, as the loan is secured by the hard asset value of the collateral property. Typically, the biggest loan one can expect would be between 65% and 80% of the property value. That is, if the property is worth $100,000, the lender would advance $65,000–80,000 against it. This low LTV (loan to value) provides added security for the lender, in case the borrower does not pay and they have to foreclose on the property.
Loan structure
A hard money loan is a species of real estate loan collateralized against the quick-sale value of the property for which the loan is made. Most lenders fund in the first lien position, meaning that in the event of a default, they are the first creditor to receive remuneration. Occasionally, a lender will subordinate to another first lien position loan; this loan is known as a mezzanine loan, a second lien or a junior lien. Hard-money lenders structure loans based on a percentage of the quick-sale value of the subject property. This is called the loan-to-value or LTV ratio and typically hovers between 60 and 80% of the market value of the property. For the purpose of determining an LTV, the word “value” is defined as “today’s purchase price.” This is the amount a lender could reasonably expect to realize from the sale of the property in the event that the loan defaults and the property must be sold in a one- to four-month timeframe. This value differs from a market value appraisal, which assumes an arms-length transaction in which neither buyer nor seller is acting under duress. Below is an example of how a commercial real estate purchase might be structured by a hard-money lender:
65% Hard money (Conforming loan)
20% Borrower equity (cash or additional collateralized real estate)
15% Seller carryback loan or other subordinated (mezzanine) loan
History
Hard Money is a term that is used almost exclusively in the United States and Canada where these types of loans are most common. In commercial real estate, hard money developed as an alternative “last resort” for property owners seeking capital against the value of their holdings. The industry began in the late 1950s when the credit industry in the U.S. underwent drastic changes (see FDIC: Evaluating the Consumer Revolution).
The hard money industry suffered severe setbacks during the real estate crashes of the early 1980s and early 1990s due to lenders overestimating and funding properties at well over market value. Since that time, lower LTV rates have been the norm for hard-money lenders seeking to protect themselves against the market’s volatility. Today, high interest rates are the mark of hard money loans as a way to compensate lenders for the risk that they undertake.
Cross collateralizing a hard money loan
In some cases, the low loan-to-values do not facilitate a loan sufficient to pay off the existing mortgage lender, in order for the hard-money lender to be in first lien position. Because a security interest in the property is the basis of making a hard money loan, the lender usually always requires first lien position of the property. As an alternative to a potential shortage of equity beneath the minimum lender Loan To Value guidelines, many hard-money lender programs will allow a “Cross Lien” on another of the borrowers properties. The cross collateralization of more than one property on a hard money loan transaction, is also referred to as a “blanket mortgage”. Not all homeowners have additional property to cross collateralize. Cross collateralizing or blanket loans are more frequently used with investors on Commercial Hard Money Loan programs.
Commercial hard-money lender or bridge lender programs
Commercial LEt and bridge lender programs are similar to traditional hard money in terms of loan to value requirements and interest rates. A commercial hard money or bridge lender will usually be a strong financial institution that has large deposit reserves and the ability to make a discretionary decision on a non-conforming loan. These borrowers are usually not conforming to standard or other residential conforming credit guidelines. Since it is a commercial property, they usually do not conform to a standard commercial loan guideline either. The property and or borrowers may be in financial distress, or a commercial property may simply not be complete during construction, have its building permits in place, or simply be in good or marketable conditions for any number of reasons.
If the property owner defaults on the commercial hard money loan, the property owner may lose the property to foreclosure to the investors. The property owner may have to sell the property in order to satisfy the lien from the commercial hard-money lender, and to protect the remaining equity on the property.
Hard money rate
Hard Money Mortgage loans are generally more expensive than traditional sub-prime mortgages. However all mortgage loans are not necessarily considered to be a high cost mortgage. Generally a hard money loan carries additional risk that a borrower is aware of. Private investors are generally only willing to create hard money loans in return for a very high interest rate plus five points to secure the loan. Rather than selling the property a borrower will opt to keep the loan and if a lender is willing to assume some of the risk by offering a hard money loan.
Hard money points
Points on a hard money loan are traditionally 1 to 3 more than a traditional loan, which would amount to 3 to 6 points on the average hard loan. It is very common for a commercial hard money loan to be upwards of four points and as high as 10 points. The reason a borrower would pay that rate is to avoid imminent foreclosure or a “quick sale” of the property. That could amount to as much as a 30% or more discount as is common on short sales. By taking a short-term bridge or hard money loan, the borrower often saves equity and extends his time to get his affairs in order to better manage the property.
All hard money borrowers are advised to use a professional real estate attorney to assure the property is not given away by way of a late payment or other default without benefit of traditional procedures that would require a court judgment.
Questions – want to find out more
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