Once upon a time, hard money or private-capital lending evoked images of unsavory lenders congregating in back alleys, making high-cost loans to borrowers that had to be paid back almost immediately, or else. Fortunately, times have changed.
Private or hard money loans are now regularly used as financing sources for capable commercial mortgage brokers to meet their clients’ needs. Like all financing options, however, private capital comes with a set of pros and cons.
Speed and flexibility
One advantage of hard money is that the lender typically focuses far more upon the value of the proposed collateral than on a borrower’s credit history, financial statements and so on. Another advantage is that even though a borrower’s cost of capital is usually higher than with a conventional loan, hard money lenders can typically perform far faster and with less red tape than traditional lenders, such as banks.
The best private-capital lenders know their niche well and do not try to be all things to all people, opting instead to concentrate upon particular geographies or loan parameters. Some focus on small-balance loans of less than $3 million in a particular region. Others specialize in large bridge or term loans on a nationwide basis. Although specialty asset classes in smaller markets typically result in lower loan-to-value ratios, some lenders will consider nontraditional asset types or locations on a case-by-case basis.
Whatever the focus, private-capital lenders typically emphasize the amount of equity borrowers have in their proposed collateral. This allows the lender to overlook a borrower’s imperfect credit profile or prior missteps. The hard money lender wants to see that a client has sufficient skin in the game and the ability to service the requested loan. Most lenders will require a prior title report, a land title survey, an environmental assessment and trustworthy appraisal. Borrowers and mortgage brokers don’t always approach a lender fully prepared with these documents in hand, but coming prepared will make a good first impression.
Hard money loans are especially useful for borrowers who occupy the property they are using as collateral. Because owner-occupied properties don’t generate income on their own, it is usually harder for the owners to secure bank financing for the property. Private lenders are more flexible. In some cases, private lenders also can dispense with the need for a borrower’s personal guarantee of the underlying indebtedness, another traditional lending practice that lowers the risk to the lender. In cases of default, the hard money lender tends to focus their recovery efforts on the asset itself.
Just as a prospective lender is evaluating your borrower and the deal in question, you should separately evaluate any prospective lender you refer clients to.
Find reputable partners
Borrowers and brokers need to be wary of any lender offering unclear parameters or requiring high upfront fees. Most reputable private lenders will provide a loan-approval letter within days, not weeks, delineating not only the proposed loan terms and fees, but also the refundability of any required upfront deposits.
Just as a prospective lender is evaluating your borrower and the deal in question, you should separately evaluate any prospective lender you refer clients to. Reputable private lenders will protect your commission on the proposed transaction and will, on request, provide a list of previous borrowers and brokers with whom they’ve worked. Conversations with a lender’s past clients can shed considerable light on that lender’s business practices, such as how fair and reasonable they are in working through various transaction-related issues. This will help you decide whether to proceed with that lender or look elsewhere.
A direct lender can provide numerous other advantages to the savvy commercial mortgage broker. These lenders tend to have the ability to commit to and fund deals quickly. Direct lenders make their own funding decisions with their own capital, require no outside approvals, and typically retain and service all loans in-house. Some direct lenders will allow their most capable mortgage brokers to “table fund,” meaning the broker can originate, process and close loans in their own name, with all loan documents assigned at the closing table to the lender.
The best funding partner varies with the particulars of a given loan, but reputable direct private lenders have features in common. They provide a timely approval letter that explains the financing terms, are transparent about the approval and funding process, and have considerable experience deploying capital across multiple market cycles.
Hard money drawbacks
Hard money comes with some downsides, however. Private capital lenders invariably charge higher interest rates and fees. Many such lenders will only lend for shorter terms — typically two years at most.
This requires the borrower to either refinance or sell the property. This potentially could occur at an inopportune time, such as a market downturn, recession or decline in the borrower’s business. Some private lenders follow an alternative business model, however, offering terms of up to 10 years or fully amortized loans. For borrowers considering an investment with considerable upside potential, the somewhat greater cost of capital presented by hard money lenders is frequently offset by a direct lender’s speed of execution, and its flexibility in structuring and documenting the loan.
This is particularly true with value-add real estate opportunities in which a borrower acquires an underperforming asset, corrects any deferred maintenance, and renders the property attractive and ready for an owner or tenant to occupy. The borrower will need to decide whether to flip the property or hold it for a longer term. The significant value created by the borrower who quickly acquires control of the property is generally far more significant than the slightly higher cost of capital posed by the private loan.
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Private or hard money loans are often thought of as loans of last resort, but the modern commercial mortgage broker simply recognizes them as yet another tool in an ever-evolving toolbox. Used properly, the hard money loan can make an opportunity a reality and also cement your relationship with a borrower for years to come.