Hard-Money
A hard money loan is a specific type of asset-based loan financing in
which a borrower receives funds based on 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 not yet qualifying for
traditional financing. Whereas hard money
often refers to not only an asset-based loan
with a high interest rate, but can signify a
distressed financial situation such as
arrears on the existing mortgage or
bankruptcy and foreclosure proceedings are
occurring.
Many hard money mortgages are made by
private investors, often in their local
area. Usually the credit score of the
borrower is not important. The loan is
purely against the collateral of the
property. Typically the maximum loan to
value is 65-70%. That is, if the property is
worth $100,000 you can borrow $65,000-70,000
against it. This low LTV is to cover the
lender if the borrower does not pay and they
have to foreclose on the property. Evaluate
the mortgage collateral
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 or second 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 60-70% 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 carry-back 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 US 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
protect the loans and lenders from the
considerable 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 the
existing mortgage lender off in order for
the hard money lender to be in first lien
position. Because securing the property is
the basis of making a hard money loan, the
first lien position of the lender is usually
always required. 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 borrower’s
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
Commercial hard money is similar to
traditional hard money, but may sometimes be
more expensive as the risk is higher on
investment property or non-owner occupied
properties. Commercial Hard Money Loans may
not be subject to the same consumer loan
safeguards as a residential mortgage may be
in the state the mortgage is issued.
Commercial hard money loans are often short
term and therefore interchangeably referred
to as bridge loans or bridge financing.
Commercial hard money lender or bridge
lender programs
Commercial hard money lender 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 the standard
Fannie Mae, Freddie Mac 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.
Some private investment groups or bridge
capital groups will require joint venture or
sale-lease back requirements to the riskiest
transactions that have a high likelihood of
default. Private Investment groups may
temporarily offer bridge or hard money,
allowing the property owner to buy back the
property within only a certain time period.
If the property is not bought back by
purchase or sold within the time period the
commercial hard money lender may keep the
property at the agreed to price.
Traditional commercial hard money loan
programs are very high risk and have a
higher than average default rate. If the
property owner defaults on the commercial
hard money loan, they may lose the property
to foreclosure. If they have exhausted
bankruptcy previously, they may not be able
to gain assistance through bankruptcy
protection. 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.
Legal and regulatory issues
From inception, the hard money field has
always been formally unregulated by state or
federal laws, although some restrictions on
interest rates (usury laws) by state
governments restrict the rates of hard money
such that operations in several states,
including Tennessee and Arkansas are
virtually untenable for lending firms.
Commercial lending industry
Thanks to freedom from regulation, the
commercial lending industry operates with
particular speed and responsiveness, making
it an attractive option for those seeking
quick funding. However, this has also
created a highly predatory lending
environment where many companies refer loans
to one another (brokering), increasing the
price and loan points with each referral.
There is also great concern about the
practices of some lending companies in the
industry who require upfront payments to
investigate loans and refuse to lend on
virtually all properties while keeping this
fee. Borrowers are advised not to work with
hard money lenders who require exorbitant
upfront fees prior to funding in order to
reduce this risk. If you feel you have been
the victim of unfair practices, contact your
state's attorney general office or the
office of the state in which the lender
operates.
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. 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.
Interest rate on hard money
The rate is not dependent on the Bank Rate.
It is instead more dependent on the real
estate market and availability of hard money
credit. As of 2007 and for the past decade
hard money has ranged from the mid 15%-25%
range. When a borrower defaults they may be
charged a higher "Default Rate". That rate
can be as high as allowed by law which may
go up to or around 25%-29%.
Hard money points
Points on a hard money loan are
traditionally 1-3 more than a traditional
loan, which would amount to 3-6 points on
the average hard money 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 which
would require a court judgment.
