American football is a rigid sport. It forces players to work within a structured environment that allows for very little freedom, especially for linemen, whose job is to block the attacking defense. Linemen are expected to do essentially the same thing over and over.
Rugby, however, has a different set of rules. Players participate in all parts of the game —offense, defense, running with the ball, kicking it, passing it, scoring, punting and tackling. Rugby is every lineman’s dream. The game is fluid and allows each player an opportunity to participate in all phases of the sport. It gives players more freedom.
Rugby, by analogy, is what alternative funding (or hard money) has become in the finance world. The sky is the limit, and the deal-structure possibilities are wide-ranging. Private nonbank lenders have the flexibility to lend based solely on the equity a borrower brings to the deal. After that, everything else is examined as an additional consideration.
Is the borrower a good credit risk? Does he have reserves, partners and income? In the private lending world, as a lender or mortgage broker representing a borrower, these factors can be taken into consideration and then, based on a risk-return analysis of a proposed deal, a decision can be made to lend or borrow and what to charge or pay.
Conventional banks have a place in the commercial mortgage arena. As a commercial mortgage broker, if your client has a credit score of 800, a large downpayment, great income and a solid project, they will likely qualify for a low-interest bank loan. Just like football linemen, this bank loan works within a narrow scope.
Alternative lending, or hard money, however, gives the underappreciated lineman the ball and the option to run with it. For millions of entrepreneurs, securing hard money financing through private money lenders may be the only way they can qualify for a commercial mortgage loan. These nonbank lenders have paved the way for a wider range of businesses to access capital for growth.
Hard money pitfalls
Borrowers and investors in the hard money arena can often be overzealous. Borrowers coming in with the wrong expectations can easily fall prey to unscrupulous lenders or brokers. One of the biggest red flags that a borrower can encounter is a request for a large
upfront fee.
Many hard money lenders take minimal or no fees upfront. If your lender is asking for more than an appraisal fee or an inspection fee, you should run. As a mortgage broker, make sure your clients are not duped by a lender or another broker seeking short-term, upfront fees of five or six figures. Brokers, and the borrowers they represent, should be aware of the danger that such a lender or broker is likely not on the up and up and may well run off with the money.
Here’s how such a scheme might work. Don is an investor who is seeking a $500,000 loan. His collateral is 10 acres of beach property in a spectacular area. After further investigation, it’s discovered that Don is using $400,000 of this loan to cover an upfront fee to be paid to a loan broker of questionable character.
Interest rates are another area where caution is warranted. Most hard money lenders have a niche they cater to. Some of these hard money lenders are fast and expensive, some work with fix-and-flip projects, and others focus on apartment or land deals. Each one has their own expertise, loan range and parameters.
The trick is to find the hard money lender that fits best with your project at the right price. Be warned that hard money can be expensive, so borrowers and the mortgage brokers they work with will need to keep up with the interest and fee trends. Making the right deal can facilitate healthy returns.
Kent is a developer who was financially devastated by the 2008 real estate crash. He is knowledgeable about land acquisitions and development. Kent tied up 20 acres on the West Coast but was unable to find a lender to fund the $1 million purchase price. He called a hard money lender only a few days before his purchase offer was set to expire. The lender liked the land and made the loan within the two-day window. Kent sold that land 30 days later for $2 million. Remember, hard money used the right way works out for all parties.
There also are some hard money lenders who play the loan-to-own game. In other words, the lender makes the loan hoping to later foreclose and own the property serving as collateral. Every hard money lender is prepared to foreclose to protect their financial interests, but some make that loan with the goal of taking over the property.
Although it can be very profitable for the lender, the loan-to-own approach is a morally gray area — and, in some scenarios, it can even cross legal lines. Because of this, as a commercial mortgage broker or borrower, it’s very important to make sure the loan deal makes economic sense. If a borrower can’t pay back the loan, don’t take it out.
Hard money perks
Without a doubt, many borrowers need money quickly, whether it’s because of an expiring deadline, a looming foreclosure or a great business opportunity that needs to be closed fast. A typical bank loan can take anywhere from 30 days to six months to close and a borrower may get rejected at the finish line. Speed in closing, however, is probably the greatest benefit a hard money lender can offer a borrower.
On another front, banks require a borrower to have good credit, cash reserves and a proven history of income. Banks are bound by federal regulations to lend based on these factors, and it’s sometimes hard for banks to overcome a borrower’s shortcoming in even one of these areas.
Hard money lenders, by contrast, look at credit, cash reserves and income to some degree, but most often make loans despite deficiencies in these three areas. Their focus is on a fourth piece of the pie: equity. The amount of equity a borrower brings to the deal — including the equity in property used to secure the deal — is the main ingredient of the hard money loan. As a broker, if your client has the equity, they most likely can get a loan.
Finally, arguably the greatest benefit a hard money lender can provide to the borrower is creativity. Hard money lending is a vehicle for originating loans that fall outside the boundaries for a typical commercial mortgage loan. Hard money loans can involve no money down, owner-provided financing in second positions, judgements acquired at discounts and released as part of a loan process, and more.
Some hard money lenders will even negotiate with the Internal Revenue Service to get loans done. Would banks do that? No, but they don’t need to. The experienced hard money lender is like a rugby player who has the freedom to play multiple positions in the game of finance.
