HARD MONEY LENDING FAQ
By: Jan B. Brzeski and Gregory S. Hebner
WHAT IS HARD MONEY LENDING?
WHAT IS A HARD MONEY LENDER?
A hard money lender is an investor who makes loans secured by real estate, typically charging higher rates than banks but also making loans that banks would not make, funding more quickly than banks and/or requiring less documentation than banks.
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.
WHY DO HARD MONEY LENDERS EXIST?
Hard money lenders exist because many real estate investors need a quick response and quick funding to secure a deal when looking for a real estate loan. Banks and other institutional lenders that offer the lowest interest rates don’t provide the same combination of speed and transparency in their decision making process, along with quick access to capital.
WHEN DOES IT MAKE SENSE FOR A DEVELOPER 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 OTHER TERMS FOR HARD MONEY LOANS?
Hard money loans are also sometimes referred to by the following terms: (1) private money loans; (2) bridge loans; (3) short-term loans; (4) transitional loans; (5) asset-based loans; (6) rescue loans.
ARE HARD MONEY LOANS USED MAINLY WHEN THE BORROWER IS IN DISTRESS?
Some hard money lenders do focus on distressed situations such as when the borrower has another loan in default and needs to refinance. This is particularly true for commercial bridge loans.
In the single family residential arena, most hard money lenders shy away from distressed borrowers who are owner-occupants. Lenders are not eager to foreclose on a borrower living in his or her own house. Furthermore, regulations make this type of foreclosure much more time consuming and difficult as compared to an investor-owned property.
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 acceptable 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. When should you use a hard money lender?
A borrower might consider using a hard money / private money loan in situations where he or she is willing to pay a higher interest rate and/or higher up-front fees in the interest of gaining access to capital more quickly, dealing with less bureaucracy and more transparency during the application process, and finding capital to pursue an opportunity that banks will not finance, either because they are unwilling or unable to do so
What does the term “hard” mean in “hard money lender”?
The “hard” in hard money lending refers to the higher price which is charged to borrowers both in terms of interest rates (typically high single digits or low double digits) and higher loan origination fees (often around 2 percent of the loan amount, versus 1 percent or less for a typical bank loan).
Who funds hard money loans?
Hard money loans are typically funded by individuals or by funds that aggregate capital from multiple wealthy investors. Individuals who invest directly into a single loan are known as trust deed investors. Many trust deed investors are real estate investors/owners who invest in “bridge loans” to keep available capital working to generate a higher rate of return, rather than leaving the capital in banks earning minimal interest rates. Investors who prefer to invest passively in a fund are typically not as experienced in real estate investment and choose to pay the fund manager a fee to oversee the process of sourcing, selecting and originating a series of bridge loans.
How do I get a hard money loan?
The best way to secure a hard money loan is to know or be referred to a reputable hard money lender. The prospective borrower can simply call and describe the nature of the project for which capital is desired. When presenting a project to a lender, the borrower should be prepared to provide the following information:
Deadlines and dates which are critical to the transaction (for example, the closing date for a purchase if the borrower is seeking a purchase money loan); The specific property address; Whether the loan is for a property acquisition or refinancing of an existing loan; The purchase price of the property; The intended renovation budget; The intended asking price for the property (assuming the project is going to be resold after renovation);
What companies provide hard money loans?
A variety of companies provide hard money loans, with some specializing in commercial, some residential, and some investing in both categories. Major commercial banks often have bridge lending programs targeted at opportunities in the $20MM and greater loan size, while many privately operated funds specialize in the $10MM – $20MM range. At the $5MM and less loan size, there are mostly small regional operators, often comprised of real estate developers with sufficient cash liquidity that prefer to invest short term real estate loans rather than the stock or bond markets.
On the residential front, in addition to private investors there are a number of funds that will invest in single family homes, including Arixa Capital Advisors, Lone Oak Fund, Genesis Capital, Athas Capital and Anchor Loans.
Why are so many hard money lenders based in California?
California is home to many leading hard money/bridge lenders, including those listed in the prior paragraph. California has a tradition of private money borrowing and investing; it is a large state with huge numbers of properties and developers; and it is a “non-judicial foreclosure state.” This means that if borrower defaults, the lender can get control of the underlying property fairly quickly to get repaid (as long as the home is not owner-occupied). In contrast, some states with a judicial foreclosure process are less appealing for private lenders, because the foreclosure process can be very long and arduous.
DOCUMENTATION, TERMS & CONDITIONS FOR HARD MONEY LENDING
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.
What is the purpose of a Letter of Intent?
The purpose of a Letter of Intent (LOI) for a hard money loan is to provide a quick means to be sure that both the prospective borrower and lender are on the same page. Although this document is not legally binding on either party, it serves to put the prospective deal “in writing” and helps to avoid any miscommunication or misunderstandings.
Why does the lender need title insurance?
Title insurance helps protect someone who has purchased real estate against another party making a claim challenging the ownership of the property and the seller’s right to enter into a transaction. Well known title insurance companies include Fidelity National, First American Title, and Chicago Title. The title insurance company will handle any issues that arise during the property sale, and if a competing claim of ownership is deemed legitimate, the title insurance company is responsible for payment of any fees to the claimant. The reason why hard money lenders insist on being covered under title insurance is to enjoy the same protection as the borrower.
What happens in the event that a Mechanic’s Lien is filed on a property?
A Mechanics Lien is used in the construction trade when a property owner either fails to pay a general contractor for services rendered, or the general contractor fails to pay sub-contractors according to the terms of their agreements. Since title insurance does not provide any protection against this, hard money lenders will protect against possible Mechanics Liens by making sure that if a loan includes a renovation budget, that all sub-contractor and general contractor releases are properly executed before disbursing funds to a borrower.
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.
Do hard money lenders require deposits?
Whether or not hard money lenders / bridge financing lenders require non-refundable deposits varies from one lender to another. This often depends on the following criteria:
How regularly does the lender make loans?
Willingness to risk the borrower changing their mind
A deposit, when charged, can vary from $1,000 to tens of thousands of dollars in total.
Deposits are usually not required for hard money loans on single family homes.
Is a hard money loan personally guaranteed?
Some lenders may require that a hard money loan be personally guaranteed by the borrower, although there are instances where lenders are willing to offer no-recourse loans based on the borrower’s history and the appeal of the specific opportunity.
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.
Should I give a deposit to a hard money lenders?
Prospective borrowers for a hard money loan should think carefully before paying a deposit to a lender; if a loan is for a single family home renovation there should not be a deposit charged. However, for larger, more complex transactions with a lot of underwriting requirements, payment of a deposit is more warranted.
What are typical hard money lenders fees?
The fees usually associated with a hard money loan will include origination fees of 1-3 points, possibly a deposit fee, plus an underwriting fee to ensure the loan conforms to necessary lender requirements.
Borrowers should be wary of individuals or entities trying to make money from the deposit fee with the hope of getting a loan done “after the fact” due to a lack of available capital.
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 is the maximum loan-to-cost for hard money lenders?
Hard money lenders utilize two different measures to evaluate deals: loan-to-cost (LTC) and loan-to-value (LTV) metrics. While risk tolerance is highly dependent upon the lender, most prudent private money lenders will not exceed a loan-to-cost ratio of 75 percent, while the loan-to-value ratio is usually kept in the 60 to 65 percent range to ensure a sufficient safety margin.
Lenders may use the lesser of the LTC or LTV values to assess a loan, depending on when the property was purchased; in the instance of more recent purchases, lenders will look at what the borrower paid for the property.
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.
Are hard money loan interest rates usually fixed rate or floating rate?
Most hard money lenders that specialize in single family homes offer loans that are based on a fixed rate but with commercial properties, a floating rate is more common due to the longer term of maturity.
It is worth noting that floating rate loans may have a lower initial rate, but this can quickly exceed fixed rates if interest rates rise during the term of the loan.
Are all hard money loans backed by real estate?
While most hard money loans are backed by real property as collateral, some bridge loans are not real estate backed, the most notable exceptions existing when a hard money loan is backed by another loan from a third-party institution.
Are owner-occupied home hard money loans different from all other types?
Owner occupied hard money loans are different from other types, due to state laws requiring extensive documentation intended to protect the borrower from predatory lenders. Many hard money lenders are not set up for compliance in this regard and therefore will not make loans for owner-occupied residential properties.
Can borrowers get a hard money loan even if there is another loan already in place?
It is possible for borrowers to secure a hard money loan even if another loan is in place, although this will require either the borrower getting a new hard money mortgage to replace the existing first mortgage or qualifying for a subordinate junior loan which leaves the first mortgage in place.
When does it make the most sense for borrowers to use hard money loans?
While seeking a hard money loan is a personal decision which will vary depending on the individual, situations where hard money loans are generally a good recourse are when the borrower is anticipating a large profit from a real estate transaction or realizing large savings in a short amount of time.
How can borrowers negotiate the best rate on a hard money loan?
A borrower can negotiate the best rate for a hard money loan by having multiple lenders willing to compete for the business. This in turn means that the prospective borrower needs to be well-organized and have all necessary documentation ready for inspection; ideally having a strong credit history; and impressing upon prospective lenders that the proposed project meets their needs and risk profile.
What risks do borrowers face when working with a hard money lender?
Borrowers that secure a hard money / private money loan face the following risks:
Risk of lost time if a lender does not perform; Risk of lost deposit if a deposit is required, and the lender does not ultimately make the loan; Market risk and execution risk on the underlying project; Risk of associating with a less than reputable lender; Risk that the lender fails to come up with the loan amount in a timely manner, possibly endangering a deal (for example, if money is not placed into escrow by a pre-determined deadline).
WHAT IS THE DIFFERENCE BETWEEN HARD MONEY LENDERS & BANKS?
How are hard money lenders regulated?
Hard money lenders are typically regulated at the state level via the Department of Real Estate, as at least one person associated with hard money lending must have a valid Real Estate Broker License. Additional licensing requirements may be required on a state-by-state basis.
Cross-state transactions fall under the jurisdiction of both states involved and are subject to each state’s respective requirements.¬† Securities licenses are usually not required for hard money lending unless a loan is classified as a securities offering due to the loan being syndicated to multiple investors.
How do hard money lenders compare with banks?
Hard money lenders are licensed differently with less regulatory scrutiny than traditional banks and can look at the merits of a loan more so than a bank, which must meet certain non-negotiable criteria to issue a loan.
How can you tell if hard money lenders are reputable?
It is essential for borrowers to ascertain whether a lender is reputable, to avoid disappointments, wasted time, and lost opportunities. A borrower can research a prospective lender using the following techniques:
Ask for references from clients/borrowers and mortgage brokers; talk to the references. Consider working with a local mortgage broker who has done transactions with that lender; Confirm that the lender has a valid Real Estate Broker License; Determine whether any complaints have been filed against the Real Estate Broker License; Consider checking with the Better Business Bureau (BBB); Find out what industry events the lender attends and ask people at the event about the lender’s reputation.
How long does it take hard money lenders to fund a loan?
It generally will take a hard money lender 30 days or less to fund a loan, although some are equipped to do this in two weeks or less.
Can borrowers who start with hard money lenders move on to working with banks instead?
It is possible for borrowers who start with a hard money lender to transition to working with a bank later in the process. This may happen if the borrower has a recent credit issue (such as a past foreclosure or bankruptcy) and the hard money lender is used to “age out” that credit issue until the borrower qualifies with the bank. A borrower may also choose to enter into a hard money loan prior to seeking a traditional bank loan in order to demonstrate performance and credit worthiness.
Borrowing from a hard money lender can act as a bridge to receiving future credit in that it builds a track record and can also enhance the borrower’s financial strength, assuming the underlying investment for which the loan is used proves successful.
Why are bank loan interest rates so much lower than hard money lenders interest rates?
Banks can offer lower interest rates than hard money lenders because banks can fund loans via retail deposits on which they pay minimal interest rates. Hard money lenders fund loans via private capital which has higher expectations. For example, in early 2013 most bank depositors earn 1% or less on their deposits while most investors in private money loans expect 7% or more, to compensate for the greater risk of loss of principal.
COMPETITION AMONG HARD MONEY LENDERS
How do hard money lenders compete?
Hard money lenders will compete on fees, interest rates, their reputation, and quality of service, which includes the ability to fund a deal quickly and being more accessible to the borrower during the term of the loan and/or flexibility in case of unforeseen events and how the lender responds to special borrower requests that may arise.
How do hard money lenders differ from one another?
Hard money lenders differ from one another in a number of ways, including their lending criteria such as loan-to-cost and loan-to value guidelines; the type of real estate on which they lend; minimum and maximum loan size; the geographic region they serve; their industry reputation; and level of service which is provided.
Do hard money lenders compete on price?
Hard money lenders will compete on price, but the reputable firms tend to be close to each other in pricing due to the competitive nature of the market. Service is typically the greatest differentiator, along with the lender’s relationships, dependability, and ability to perform once a loan is agreed to.
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.
How does trust deed investing relate to hard money lenders?
Trust deed investing and hard money lending are closely related. Trust deed investors are one of the sources of capital for the private money loans made by hard money lenders. Brokers work with trust deed investors to fund hard money loans for borrowers. In the case of funds that make private money loans, the funds can be said to be making trust deed investments when they fund a loan. For more information about trust deed investing, please see our Trust Deed Investing FAQ.
MORE ABOUT THE HARD MONEY LENDING INDUSTRY
What is the business model of a hard money lender? What is a hard money lender?
Hard money lenders use private capital to fund loans secured by real property. The business model is fairly straightforward; there are one or more investors on one side of the deal and a borrower on the other; the entity issuing or brokering the loan must charge the borrower enough to pay the investor(s) the return they are seeking and retain enough to cover their own overhead and desired profit margin.
How do hard money lenders make money?
In order to understand how a hard money lender makes money, it is necessary to distinguish between those who are brokers only serving as a matching service between borrowers and trust deed investors, and “balance sheet lenders” which originate loans and then hold those loans in a portfolio until maturity. In the latter case, the lender suffers directly if the loan goes bad, but for brokers, the risk is primarily to their reputation since they are paid “up front” and typically do not invest in the loans which they broker.
How can one find hard money lenders?
A prospective borrower can find hard money lenders through the following means:
Attend real estate events held in your local area; Ask other real estate investors; Search online; Through industry publications; Ask mortgage brokers to refer a lender; Seek referrals from real estate brokers and attorney specializing in real estate transactions.
How do hard money lenders decide how much to lend?
Hard money lenders make lending decisions based on either a Loan-to-Cost (LTC) ratio or Loan-to-Value (LTV) ratio. These ratios measure the risk of the loan by comparing the loan amount to the cost and value of the underlying real estate, respectively.
What events can I attend to learn about hard money lenders?
Prospective borrowers can learn about hard money lenders by attending real estate events sponsored by various parties; by making inquiries at local business schools about real estate-related events; through real estate industry publications; and via various professionals including title insurance representatives, mortgage brokers and real estate investment brokers. In Los Angeles, UCLA has the Ziman Center for Real Estate and USC has the Lusk Center, both of which are focused on real estate-related research, education and fostering productive relations between academia and the real estate industry.
What industry groups do hard money lenders belong to?
Hard money lenders may belong to such industry groups as the American Association of Private Lenders and the National Hard Money Association.
What jobs do hard money lenders employees do?
The employees of hard money lenders primarily perform the following job functions:
Underwriting (determining what a property is actually worth and the creditworthiness and credibility of the borrower) Marketing‚Äîto develop new borrowers and generate “deal flow” Accounting and servicing (servicing is billing borrowers for interest due and tracking interest payments) Investor relations & reporting
Why are most hard money lenders so localized?
Hard money lending tends to be hyper localized because knowledge of the local real estate market is extremely important to enable property inspection and an understanding of actual market values and transactions.
Why aren’t there more “name brand” hard money lenders?
Hard money lending is typically a localized business, with few national brands. The reasons why include the following considerations:
The ability to inspect properties and to understand the dynamics of local markets is critical to a lender’s success, hence most lenders prefer to stick to markets they know, in their own area; Lenders are heavily reliant on their reputation and referrals, which are often localized; Overly aggressive lenders that invest heavily in marketing and geographic expansion may be lax in their loan underwriting and have a high failure rate if and when investments go sour.
How can I file a complaint against a hard money lender?
Borrowers who believe that they have been taken advantage of by a hard money lender can contact their state’s Department of Real Estate (DRE) to file a complaint. Each lender must have a licensed real estate broker and the DRE allows complaints to be filed against such brokers. The complaint becomes public record and can be seen when looking up the licensed professional on the DRE website.
Is there a stigma associated with hard money loans?
Due to some unscrupulous lenders, the term “hard money loan” can have a negative connotation. This is especially true of loans made to owner-occupants in economically disadvantaged areas such as inner-city neighborhoods. In contrast, the term “bridge loan,” which means the same thing, does not generate as much controversy. Bridge loans are understood to be short-term loans to investors (not owner-occupants) who understand the role of such loans and can use them responsibly.
Do legitimate businesses use hard money loans?
Yes, many legitimate businesses use hard money loans responsibly to meet their funding needs, and to capture opportunities that require quicker funding than is available from traditional lenders.
HOW CAN I INVEST IN HARD MONEY LENDING?
How can I invest in hard money loans?
Private individuals with disposable income can invest in hard money loans through a process known as Trust Deed Investing. Such investors may invest in individual loans or in a fund that manages a portfolio of loans to mitigate the risk associated with any single loan going into default.
What are the advantages and disadvantages of investing in hard money loans?
Advantages of investing in hard money loans include reliable cash flow (quarterly or even monthly distributions of interest) and risk mitigation, assuming deals are structured and underwritten conservatively.
Disadvantages can include a lack of liquidity and if the investor is unfamiliar with real estate investment and operations, loss of principal and/or the need for active management of non-performing loans.