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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   December 2016

The Elusive Interest Rate Challenge

Several market factors can be weighed to get a better bead on the cost of hard money financing

Key Points

What impacts interest rates for hard money loans

  • The supply and demand for nonbank loans;
  • The financing timeline;
  • The loan-to-value ratio; and
  • The location of the asset. 

Finding current home-mortgage interest rates online and comparing them across lenders is an easy task. But trying to do the same in the case of hard money loans is another matter. What are today’s rates on hard money loans and will they go up or down in the near future?

Although borrowers and brokers both have questions like these regarding hard money lenders’ interest rates, there are no published daily interest rates for such loans. This is because hard money interest rates are driven by a variety of factors, the least of which are the federal funds rate or 10-year Treasury yields.

So what factors have the most influence on rates for hard money loans? Following are several insights into the dynamics of interest rates for hard money financing that might be of use to commercial mortgage brokers.

Supply and speed

Hard money loan interest rates are governed by supply and demand in the marketplace for nonbank loans. If private money loans tend to be scarce in a particular geographic location, interest rates for hard money loans are going to be higher in that location.

Over the past several years in California, for example, a large supply of private money loans has become available to borrowers. This has resulted in driving down the interest rates for hard money loans in California.

Hard money and private money lenders are similar in that they both typically provide asset-based loans that are premised more on the strength of the real estate collateral than the borrower’s financial credentials. They differ, however, in that hard money lenders tend to be organized institutions that are licensed in some way and have defined lending criteria, whereas private money can come from family, friends, business associates or investors, and financing terms are typically more flexible and negotiated deal by deal.

Hard money loans also are commonly associated with fast funding, but this faster funding often means higher interest rates. For example, the funding timeline for a conventional bank loan is 30 to 45 days, and sometimes longer. The funding timeline for a hard money loan, by contrast, is only one to three weeks.

Borrowers can get themselves in all sorts of time crunches on both purchases and refinances, and this is where hard money loans tend to be needed. Borrowers may need money to quickly take advantage of a good deal, or may need funds to pay off previous financing.

Many people don’t understand the connection between the speed of funding and the interest rate, however. A loan that has to fund in only two days, for example, will have a significantly higher interest rate than a loan that has to fund in two weeks. A commercial mortgage broker who may have reached the end of a fuse on a loan may turn to a hard money lender at the last minute. The shorter the timeline for funding a hard money loan, the higher the interest rate will be for that loan.

Value and location

One of the most important risk-based factors affecting the interest rates of hard money loans is the loan-to-value (LTV) ratio. Because these loans are collateral-based loans, the LTV ratio is a strong gauge of the interest rate.

Although everyone assumes that hard money lenders are looking at the credit-worthiness of the borrower when determining the interest rate, credit score takes a backseat to the LTV ratio in hard money lending. A high LTV ratio means the borrower is putting up comparatively less money to fund the deal, and will pay a price for that in terms of the cost of the borrower’s loan. With all other factors being equal, the lower the LTV, the lower the interest rate may be on a hard money loan, and the higher the loan to value, the higher the interest rate may be on a hard money loan.

Another important risk-based factor that influences a hard money loan interest rate is the state where the collateral for the loan is located. Hard money loans tend to be primarily asset-based, so hard money lenders must consider the time frame and cost to foreclose on an asset in any given state.

Is the lender able to foreclose on a property with relative speed and ease in a particular state? If the foreclosure process is lengthy or costly in a particular state, the interest rate on a hard money loan in that state may be higher. The potential of a lengthy foreclosure process amounts to a cost for hard money, in terms of the time lenders must wait to recover their investment in the event of a default.

Hard money loans on properties located in New York, for example, will typically have higher interest rates than hard money loans on properties in California. This is because the length of time it takes to foreclose on a property in New York is much longer than the foreclosure timeline in California. Thus, hard money lenders perceive a higher risk with doing hard money loans in New York, and that higher perceived risk usually translates into a higher interest rate.

•  •  •

Many other factors beyond those outlined can influence interest rates for hard money loans. Because hard money loan rates are not affected by the same factors that influence interest rates for traditional mortgage loans, it is difficult to predict if rates for hard money financing will go up or down at any given point in time.

For this reason, it is important to take each hard money loan submission on a case-by-case basis, never assuming an advertised interest rate by a hard money lender will be guaranteed. Before quoting a hard money interest rate to a borrower, weigh factors such as loan supply, speed, LTV and location — along with any other factors unique to the loan request that could affect the interest rate.


 


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