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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   March 2007

Transitioning to Hard-Money Lending

Learn how to make the switch from broker to banker to lender

When many people start a commercial mortgage business, they start as a mortgage broker, banker or correspondent. This is primarily because of their limited access to capital or limited experience in the business.

Over time, however, they acquire expertise, acumen and a track record. When that happens, they might gravitate toward an alternative business model that appears more lucrative — one in which they originate their own deals, underwrite them and fund them with money from third-party private investors.

Unfortunately, as people in these companies soon realize, the economics are still somewhat limited. They end up on the proverbial treadmill of constantly having to replenish their deal flow with new transactions to provide a consistent revenue stream.

In many situations, these companies keep the origination fees and give the private investor the coupon on the underlying loan minus a small servicing spread. They can miss out on the opportunity to be a hard-money lender and earn the interest income spread they would get if they were to portfolio the loans within their company.

After establishing themselves as brokers — developing the contacts, customers and referral network to sustain a business — there is another step that mortgage companies should consider. That is to become a direct hard-money lender, moving from broker to banker to lender.

Evolving from a broker to lender requires a few salient items: investor capital, strong underwriting and servicing platforms, and a credit facility for financing the loan portfolio.

Investor capital

For many hard-money lenders, 100 percent of every loan is funded through third-party investors who provide the liquidity to fund the loans. Those third parties, however, may have other business priorities or may have timing constraints. They may not always be accessible or responsive to the timing and needs of your borrowers. Further, relying on a finite pool of investors creates inherent capital constraints that can limit the growth of your loan portfolio.

The solution is to create a strong business relationship with one or two individual private investors who can provide the equity “haircut” money you need to support your loan-portfolio financing.

By converting to a full lender, you will see a different capital structure that could be less expensive and potentially more user-friendly for your customers. You can create positive leverage because you can obtain cheaper capital costs by using a lower-priced loan-portfolio credit facility. You will therefore have more funds to support the growth of your loan portfolio.


When you are a commercial broker or banker, you do not need to use your resources on underwriting, due diligence and servicing. Frequently, your deals are shipped out to another lender’s shop where the actual underwriting takes place or a brief summary is prepared for your private investors.

Once you transition to being a lender, however, you will need to cover this important facet of your business in-house. You will need experienced personnel who use all the tools available to them to maximize loan-portfolio performance. Your company should establish and maintain underwriting policy and procedures. Further, objective due diligence will need to be completed on all transactions — on the property being financed, its collateral value and cash flow, and the creditworthiness of the borrower.


Once you become the lender, you also will be responsible for billing, collections and loan management. Several software companies provide excellent loan-portfolio-servicing software that focuses on hard-money lending. This important facet of the hard-money-lending business must be given adequate attention and must be properly monitored so that the underlying portfolio continues to perform up to your expectations.

During the normal course of a loan, as long as everything is going well, the servicing functions should not be complicated. Once an asset becomes nonperforming, though, you will need to rely on people with the expertise to collect and minimize any losses to the portfolio properly. At that juncture, it is imperative to call upon experienced personnel and legal professionals.

Loan-portfolio credit facility

To maximize earnings in hard-money lending and to better control the outcome of your deals, you must be able to approve your own deals and have the liquidity to fund these loans on a line of credit for your own portfolio. This allows you to keep the upfront fees and earn an interest spread.

Obtaining a loan-portfolio credit facility is different than obtaining funds from a traditional mortgage warehouse facility. The underlying loans do not have to be sold or removed from the credit facility in any stipulated period. The essence of the facility is that — coupled with your equity capital — it becomes the means to fund your hard-money loan portfolio on a permanent basis.

The standard structure for these credit facilities is as a two- to three-year revolving credit facility with an advance rate customized for the type of assets you will fund and put on the line. For lenders to control the type of assets funded on the facility, they will establish minimum eligibility requirements that each mortgage loan must meet.

For example, in most cases, the mortgages must:

  • Be secured by certain property types located in certain approved states;
  • Have underlying loan-to-values less than a certain percentage;
  • Have individual loans less than an agreed-upon dollar amount;
  • Be covered by property and title insurance; and
  • Comply with the lender’s customary underwriting guidelines and credit policy.

In addition, the financed portfolio will need to meet more-conservative criteria such as a maximum weighted average loan amount and maximum weighted average loan-to-values. Certain financial covenants and pre-closing conditions will also be required.

Loan-portfolio credit facilities are routinely structured with a custodian who maintains control of all the underlying loan documentation. All cash proceeds from the loans run through a lock-box account.

By establishing your own loan-portfolio credit facility, you can control your own funding and underwrite and service your own deals. You will now be in the position of capturing the interest rate spread between your underlying loan yields and the cost of capital.

•  •  •

Building a well-diversified mortgage loan portfolio provides a consistent and recurring revenue stream. Transitioning from broker to banker to lender can allow you to receive this revenue stream as long as the loans are outstanding. You can also receive any prepayment fees the borrowers pay.

As a result, you can support your business in the long term. And you can build a lending franchise and loan portfolio of significant value.


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