As published in Scotsman Guide's Residential Edition, July 2012.
Many mortgage brokers and originators may think there is a magic formula hard-money lenders use to decide which loans to fund, and that if they were able to decipher this formula, they could close more transactions. This certainly is not the case. Closing more hard-money deals is contingent upon learning the fundamentals of hard-money underwriting and understanding how it differs from conventional lending.
To start, you must have a clear definition of a residential hard-money loan. Commonly referred to as bridge loans or private loans, hard-money loans, in the simplest terms, are loans backed by hard assets. The asset traditionally is real estate — either residential or commercial. The lender, therefore, focuses heavily, if not solely, on the value of the asset.
The next question is: How is a hard-money loan different from a conventional mortgage? For a conventional loan, the lender typically requests a plethora of documents to evaluate the creditworthiness of the borrower. The lender focuses on the borrower’s credit score, debt-to-income ratio, overall net worth, and the value of the property as determined by an appraiser chosen by the bank. Many conventional loans take at least 30 days to close and fund.
In addition, most conventional lenders have matrixes in which a loan must fit to get funded. A material deviation from these guidelines is not allowed. Because of these tight underwriting guidelines, many borrowers have fallen out of conventional programs.
Residential hard-money lending is radically different and significantly more flexible because lenders are privately funded. Because hard-money lenders heavily focus on the value of the hard asset that will be secured by the mortgage, they can fund a loan for a borrower with less-than-perfect credit, financials, etc. They also can close and fund a loan in a week or two.
Although some hard-money lenders use an appraiser, others may rely on their own internal underwriting of a property to determine its value based on physical inspection and a review of comparables. Hard-money lenders rarely use the cost approach to valuing a property because they typically are more concerned with what a property would sell for today as opposed to the cost of rebuilding the property. They are typically conservative in their valuations.
To value a property, a hard-money lender will pull comparable sales in a tight radius of the property — usually less than a tenth of a mile, if possible. The radius is kept low because in many urban environments, neighborhoods can be radically different a block away from the subject property. The comparables typically are within the previous four months to six months and include all sales — including short sales, bank sales, etc.
Determining which comparables to factor in an evaluation is subjective — whether it is a lender or an appraiser doing the evaluation. The lender also may consider current listings to understand the neighborhood trends and the direction of the market.
With these points in mind, it is clear that there isn’t a magic formula for hard-money underwriting. A lender can be flexible in its underwriting approach depending on the market circumstances, which allows for funding loans that a traditional lender would not fund. In addition, hard-money lenders strive to make good loans in solid markets at conservative loan-to-value ratios. The real trick may be how brokers find transactions that fit this loan profile.
Glen Weinberg is the chief operating officer of Fairview Commercial Lending, a private wholesale direct hard-money lender.
He is recognized throughout the industry as a leader in hard-money lending. Weinberg specializes in funding residential and commercial hard-money deals in Atlanta (georgiahardmoney.com) and throughout Colorado (cohardmoney.com). More information on hard-money loans can be found at fairviewlending.com. Reach Weinberg at (303) 459-6061 or email@example.com.