Basics: What is Hard Money?
Hard Money loans are non-institutional loans funded by private real estate investors, companies and funds – using their own money – secured by a first, second, or third Trust Deed against the subject property.
These types of loans are referred to by many different names, such as private money, private equity, equity, equity only, equity-based, equity-driven, or asset based.
Equity-driven mortgage loans typically require 25-50% equity in the property and/or collateral in another piece of real estate, although some lenders will accept other assets such as stocks and bonds as collateral for the loan.
These types of loans also carry a heavier burden and interest rate for the borrower for the simple reason that they also pose higher risk for the lender and are often a temporary solution that opens doors for a more permanent financial solution or exit strategy.
Equity based loans offer an alternative to strict and narrow traditional bank (institutional, conventional) financing, thereby eliminating many of the usual qualifying, credit and income underwriting guidelines and delays of banks, mortgage companies or institutional lenders for traditional mortgage loans.
Equity lenders base their decisions on the unencumbered property value, its marketability, the borrower’s exit strategy and his or her ability to repay the loan. They generally do NOT calculate debt ratios and usually do NOT take into account the borrower’s credit and income. Funding is very fast; sometimes within days of receipt of the application – a true advantage over traditional bank financing.
Basics: 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. The term “Hard Money” generally infers that the borrower has actual “hard” cash invested.
The hard money industry began in the late 1950s when the credit industry in the US underwent drastic changes.
The hard money industry suffered severe setbacks during the real estate crashes of the early 1980s and early 1990s due to lenders 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.
Legal & 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.
Basics: General Use
Use a hard money loan to:
» Purchase real estate – with a sufficient down payment (25% or more), you can secure a new 1st mortgage with a hard money loan
» Refinance a loan – to obtain cash from equity, pay off a balloon mortgage, refinance a delinquent loan to prevent a foreclosure, pay off a Chapter 13 bankruptcy, and others. You need at least 25% or more residual equity left in the property after the new loan, including points and fees, to qualify
» Add a 2nd or 3rd mortgage – hard money loans can be used as subordinate financing to existing 1st mortgages for cash out for debt consolidation, remodeling, repairs, business loans, investments, or for any other reason
» Secure a bridge loan to purchase new real estate before selling your current property
» To complete construction or rehabilitation on residential or commercial property
Note: The amount of required equity for hard money loans varies by
property type and investor.
Basics: Credit
Conventional and sub prime lenders rely on a credit grade system or “FICO” score.
The FICO system is a complex matrix measuring over 30 different variables in an individual’s credit profile. The FICO system converts the profile into a numeric score, which is added to an individual’s credit report. That score is a reflection of the computer assigned credit risk for that individual. The intent is to reduce the amount of subjectivity underwriters (credit decision makers) inject into the risk analysis process.
Borrowers with a score below 720 usually find themselves locked out of the best loan rates and terms offered. Typically, borrowers with a score below 500 are locked out of the Conventional and sub prime market altogether.
Unlike conventional and sub prime lenders, Hard Money Lenders rely on the equity position in the property to guide their credit decisions.
Basics: Qualifying
The 3 criteria you must have to qualify for a hard money loan:
1. Sufficient remaining equity in the property. (Typically 30% or more after the new loan, including points and fees. The amount of required equity for hard money loans varies by property type, location and investor.)
2. An acceptable property in a marketable area (at the investor’s discretion)
3. The ability to repay the loan to the investor (required by law)
In all cases, the general qualifying process is the same: the investor/lender uses real estate as collateral. The real estate is reviewed to determine whether it holds sufficient value for the investor/lender to be willing to take the risk of making a loan based on this collateral. The borrower’s financial state and future potential is reviewed to determine the risk factors present. And finally, an exit strategy is reviewed to determine whether the loan will be completed satisfactorily within a given time frame. Depending on the results of this due diligence process, the investor /lender determines whether – and at what rates and terms – to fund the loan.
Basics: Typical Scenarios
There are many reasons for seeking private financing. Just to name a few:
» You have bad credit, minimal credit, or NO credit – Credit Impacted: low credit scores (below 500 FICO), no credit score, poor, damaged, bad, bruised, impaired or less-than-perfect credit, limited or non-existent credit, Late Payments, Slow Pays, Consumer Credit Counseling, Collections, Charge-Offs, Repossessions, Judgments, Tax Liens, Bankruptcy, Notice of Default, and Foreclosure. (note: tax liens, current bankruptcy, judgments, clouds on title, etc., may require resolution prior to or at closing); Sufficient equity and the ability to repay the loan are generally more important than your personal credit;
» You have high debt-to-income ratios (too much debt) to qualify for a bank loan —provided you have the necessary equity in your property (or down payment) and the ability to repay the loan, our hard money lenders can make allowances for excessive debt;
» You have non-verifiable, inconsistent, or unusual income or are, Self-employed, Un-employed or Laid-off — provided you can make the loan payment, hard money lenders will accept loans made to persons who have unconventional incomes. If you have no income or means of repaying the loan, you might not qualify for a hard money loan;
» You have a rural property, unique property, nonconforming property, or mixed-use property and have found it difficult to qualify for a conventional loan, as long as there’s sufficient equity in the property, and if the investor/hard money lender deems the property a worthwhile investment, you may qualify for a hard money loan;
» You need a cash equity loan with less than perfect credit and have a 1st mortgage with a negative amortization feature — with the right amount of equity after the required adjustment for the potential negative amortization you may qualify for a 2nd mortgage hard money loan;
» You need a short-term loan to build, rehab, or remodel real estate or make improvements to raw land prior to selling the property or refinancing into long-term permanent financing (note-hard money loans used for these purposes require a future value appraisal and construction documentation for approval);
» Balloon Payment Due; Refinance your initial balloon loan into a more traditional loan structure, on or near the date the balloon payment becomes due;
» Complex financing structures. The property is in the name of a “non-natural person” – such as a trust, LLC, partnership, corporation, Non-profit organizations (churches, foundations) or an entity – rather than an individual;
» Property has characteristics making it difficult to obtain a bank loan, including but not limited to: Partially or nearly completed construction of building, Property improvements – Rehab, High Vacancy – loan is needed to increase occupancy of income property, Seismic (Earthquake) retrofitting;
» You want to remain anonymous. A borrower/investor may not want the transaction on their credit report or the mortgage in their name. Unlike most conventional financing hard money lenders do not report to credit agencies and allow title to be held by an entity;
» You want to maintain your privacy. Sometimes individuals prefer to arrange private financing for reasons of privacy. For example, some people would prefer to buy a recreational property with private funds vs. institutional financing. They simply do not want their financial institution to know about all of their financial dealings;
» You need a business loan secured by equity in real estate, but cannot qualify or wait for a conventional business, commercial, or SBA loan;
» You are a Foreign National with no long-term U.S. employment or other assets;
» Creative transactions such as: interest only payments, partial deed release, and participations are usually considered;
» Purchase of Note(s) secured by Deed(s) of Trust (performing & non-performing);
» Note Hypothecations (Loans secured by Assignment of Note(s) & Deed(s) of Trust);
» Quick funding for time sensitive loans;
» Loss of bank loans, for any reason, including, {Turn-downs, previously Declined} declines and excessive conditions;
» You have a Loan (a borrower and / or a property) that falls outside the guidelines of traditional financial institutions and sub-prime lenders; Such as – Complete workouts to pay off heirs and partners of probate estates, Estate and/or Property held in Probate (Trusts, Family Limited Partnerships, Irrevocable Trusts, corporations, etc.), Current Notice of Default/Sale, Distressed Property Purchase, Property in Receivership, Remove an existing NOD, Tax Liens/Judgments, Other Liens (Homeowners Associations, property taxes, etc.), Foreclosure Bailout or Receivership, Bankruptcy (Old or current), Cash-out Refinance, Divorce, Medical Emergency, Unemployed, etc. With “private lenders” the hard assets are the key.
Basics: Considerations
Do not consider a hard money loan if …
» You would have less than 30% or more equity remaining in the property after the new loan, including any points and fees financed (Note: the amount of required equity for hard money loans varies by property type and investor);
» You are looking for a low-interest rate loan, or a loan with low points and fees;
» You cannot verify any source(s) of income or employment;
» You cannot repay the loan according to the terms of the Note;
» You are looking for an unsecured or personal loan, or open-ended line of credit;
» You are not willing to pay for and obtain a current value appraisal, if required;
» You are not willing or able to provide a “future value” appraisal for a hard money construction loan or remodel loan, including an itemized cost sheet, plans, blueprints, a licensed contractor, and permits where required;
» You are looking for an “angel” or speculative investor to fund a project without sufficient collateral or personal equity stake;
» Your property is in poor physical condition, or has extensive deferred maintenance (unless the loan is used to verifiably renovate the property).
Basics: Interest Rates, Terms, Points & Fees
Interest rates, terms, points & fees for hard money loans:
» Interest rates vary between 8.00%* and 18.00%*, depending on the investor, borrower qualifications, loan amount and purpose, property type, location, lien position, term, prepay period (if any) and any applicable state and federal law; state and federal regulations for Section 32, AB489, and any/all other federal and state-level predatory lending regulations.
» Terms vary between 90-days and 30 years, mostly interest-only (some amortizing loans), depending on the investor, borrower qualifications, loan amount and purpose, property type, location, lien position, term, prepay period (if any) and any applicable state and federal law; state and federal regulations for Section 32, AB489, and any/all other federal and state-level predatory lending regulations.
» Points: 2 to 10 points charged, depending on the investor, loan amount and purpose, borrower qualifications, property type, location, lien position, term, prepay period (if any) and any applicable state and federal law; state and federal regulations for Section 32, AB489, and any/all other federal and state-level predatory lending regulations.
» Fees: processing, underwriting, title insurance, escrow, doc prep, recording, wire transfer, title messenger, survey, and other fees also apply when applicable. Appraisal fee, where required, is prepaid by borrower C.O.D. at the time of service.
*Indicates the Note rate, not APR. APR will vary based on total finance charges, term, and state law where applicable.
Basics: Urban Legend
There is a common misconception about “hard” money-lenders & borrowers.
Fallacy:
Hard money loans are made by shady characters to borrowers who are desperate, in trouble, and without options.
Fact:
Hard money lenders can be private individuals with a strong positive net worth who have money to invest, an individual with a self directed IRA, an individual that offers seller assisted financing, a real estate investor, an investment club, a trust/pension fund or a private company – all with the desire to receive a fair return (commensurate with risk) on their investment.
Hard money borrowers are, most often, stable individuals or real estate investors or investment companies that have circumstances which fall outside the guidelines of traditional financial institutions and sub-prime lenders or opportunities that require speed or flexibility unavailable through more conventional financing.
Remember you’ll call us when the Bank Says No!!!