At one time or another, just about every commercial mortgage broker will get a call from a concerned borrower lamenting that one or more banks have turned down their loan application. They’ll ask the broker if they can help find another loan source.
The truth is that if a loan file meets a bank’s underwriting requirements, the bank will almost always fund the loan. But what happens when the borrower or the property (or both) is outside of the bank’s often narrow criteria? The solution to this dilemma may be a lesser-known lending system that exists parallel to the ubiquitous banking system. It’s called hard money lending, and it can offer real solutions for brokers and their clients.
In general, hard money loans are high-interest, short-term bridge loans that are primarily used in real estate transactions. These loans are offered by companies and high net worth individual investors. Just like in the banking universe, hard money lenders use the same contracts, mortgages, liens, titles and title insurance. This type of lending, however, is usually based on a borrower’s real estate equity, not on their credit or income.
Pricing varies on a nationwide basis, but on average, hard money loans demand 10% to 12% interest rates, plus several points in loan fees for a six- to 12-month term. The loan-to-value (LTV) ratio averages about 65% and the loan-to-cost ratio is about 75%. Loan fees and closing costs can often be included in the loan amount. Many of these lenders will offer an interest reserve of three to six months through the loan proceeds when the LTV allows. And they can close a loan in a matter of days as opposed to weeks or months at the average bank.
Some borrowers will no doubt find hard money loans to be expensive. But this is opportunity money. With the flexibility and speed of hard money, a mortgage broker’s clients will close more loans and flip properties much more quickly compared to bank loans. And it’s opportunity business for the mortgage broker: If the borrower makes more money, the broker makes more money.
Typical hard money loans are used to help pay for such projects as a fix-and-flip on a single-family investment home. For new real estate investors, these projects are relatively affordable and easy to understand, and they have the broadest buyer base for the finished products.
While some borrowers on these projects will qualify for loans from a bank or credit union, others may not for a number of different reasons — including low credit scores or too many bank loans on other projects. This is where hard money lenders can ride to the rescue. Even borrowers who qualify for a bank loan may choose to work with a hard money lender due to the quick closing and fast access to cash.
The right fit
Borrowers seeking alternatives to banks may find national hard money lenders that can meet their needs. But they also should look for small, local lenders that are active in nearly every town across the country. Many of these lenders are individuals who are experienced with helping entry-level fix-and-flip borrowers. They may be commercial real estate brokers, title company employees, attorneys or even retired bankers.
Local lenders will know the surrounding market better than any national lender because they live and work in it every day. And they’re eager to do business. They will move quickly to meet and talk with a borrower, then view the property. Often, they’ll make a loan offer that day, if not that hour.
Finding these local lenders, however, may take some work. The larger players in this field can often be found online or at real estate conferences in the area, but smaller lenders without websites may require some sleuthing. A good place to start is with a state’s online business records. Many states offer downloadable and searchable lists of registered mortgage lenders. The secretary of state’s corporations division, or the local equivalent, is another great source.
Another method for mortgage brokers is to simply call and ask local title and escrow officers, residential and commercial real estate brokers, and attorneys who specialize in real estate issues for any hard money lenders they may know. It pays to be nice in this business, so mortgage brokers should always be sure to provide some value to these sources. Make a gesture such as offering to distribute their business cards to clients. Acts of kindness may help ensure that a broker will receive a referral.
Meet and greet
When first reaching a hard money lender on the phone, the lender is bound to ask how the caller found them. Be prepared if they want specifics. Some private-money lenders emphasize the term “private.” Give credit to anyone who may have helped along the way.
Once you’re past the introduction stage, be sure to ask about the loans that the lender likes to make. Find out which property types, locations and loan amounts the lender prefers. Always take notes.
Private mortgage lenders tend to be successful, savvy and hardworking. They don’t like having their time wasted, so be honest. Never try to sell them on a deal or attempt to “warm them up.” Stick to the facts. The lender will want to know the story behind the deal, so include a brief, clearly stated and typed narrative with only the facts. Never state anything that can’t be backed up with documentation.
If a broker truly wants to be successful in this niche sector, they should be sure to visit these properties before sending out loan proposals. Hard money lenders consider brokers who investigate the properties beforehand as more knowledgeable and more motivated to make deals.
These are equity-based deals, so lenders are most concerned with the property’s condition and value, and the borrower’s ability to complete the project on time and as planned. The LTV equation and exit strategy will be the keys to closing such loans.
Know the lender
The more that brokers learn about hard money lenders, the better they will be at targeting the right loan to the right person. Some lenders may not always have funds available to make a deal, no matter how well it fits their parameters. This is why brokers always need to know more than one lender.
A loan made by a bank is a small part of its total asset value. But any loan made by an individual hard money lender is a large portion of the person’s net worth. Understandably, they are more particular about location, property type and the borrower. For instance, if a lender makes a loan on a coffee shop and doesn’t get repaid, they may never make a loan on a coffee shop again, no matter how good the next proposal is.
Hard money lenders rarely need as much paperwork as banks, so a broker should never inundate them with documents. Start with the basics: a clearly typed loan request and a fully completed personal financial statement. Include a schedule of all real estate owned by the client, their credit reports and a current appraisal of the property, if available. Brokers should expect lenders to give them homework. In return, they should provide only the documents that a lender asks for rather than full bank files.
Once the requested information has been sent to a potential hard money lender, brokers can call to ask for an opinion. Brokers should always have their loan summaries in front of them so they can provide the facts and the narrative to the lender in the manner requested. Then they need to be quiet and take good notes on what the lender has to say. If a lender rejects the loan proposal, a broker can find out why and then go back to the borrower to see if the problems can be solved.
The niche market of hard money lending can be quite profitable. On a bank loan, mortgage brokers usually earn between 50 to 100 basis points (0.5% to 1%) of the loan amount. In the hard money world, this fee generally starts at 100 basis points and may rise to 150 or more.
Fees are paid out of escrow once the loan is closed and recorded. Land, development or construction loans are harder to complete, and may justify charging a slightly higher rate, but a broker shouldn’t get greedy. Demanding 400 or 500 basis points on a single hard money loan could end a deal before it begins.
These fees don’t decrease much as the size of the hard money loan increases, so bigger can be better. And brokering any hard money deal means a faster closing with fewer documents. A simple broker referral should earn about 25 to 50 basis points. But brokers shouldn’t get involved in daisy chains. Some hard money lenders dislike paying for even one referral source, so brokers should try to find their own lenders.
When everything comes together with a solid loan proposal, a reasonable LTV ratio, and a borrower who demonstrates an ability to complete the project before selling or refinancing to pay off the hard money loan, the broker likely has a deal. Hard money lenders tend to want a regular (but attractive) return on their money. They don’t want the property itself. If a broker gets the feeling that a lender wants the property, they should move on and find another funding source.
There are always hard money lenders ready to invest in deals that don’t quite fit the banking box. By connecting the right lenders to the right borrowers, commercial mortgage brokers can help everyone succeed. ●