By Alvin E. Terry, MBA
Business Consultant, Dynamic Business Builders
Why There Is A Need For Hard Money
A hard money loan is a specific type of financing in which a borrower receives funds based on the value of a specific parcel of real estate. Hard money loans are typically issued at much higher interest rates than conventional commercial or residential loans and are almost never issued by a commercial bank or other deposit institution.
Hard money loan is similar to a bridge loan which usually has similar criteria for lending as well as cost to the borrower. The primary difference is that a bridge loan often refers to commercial property or investment property that may be in transition and not yet qualifying for a 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 f foreclosure proceedings are occurring.
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 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 percent 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-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 of Hard Money
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 1950” 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 1980’s due to lenders overestimating and funding properties at well over 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.
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.
Hard Money Rates and Points
Currently and for the past decade hard money has ranged from the mid 10 percent to 16 percent 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 around 25 percent to 29 percent.
Points on a hard money loan are traditionally one to three more than a traditional loan. It is very common for a commercial hard money loan to be upwards of four points and as a 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 percent 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 real estate attorney to assure the property is not given away by way of a late payment or other default without the benefit of traditional procedures which would require a court judgment.
Commercial Lending Industry
Thanks to the 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. 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 are virtually impossible to defend.
It has been a pleasure to bring you valuable and useful information that can save you time and money! Good luck and be prosperous.
You may contact Alvin E. Terry, MBA @ [email protected] or by
Cell @713-392-9107.
