Hard money loans are often a good fit for a commercial real estate deal, but mortgage brokers and their borrowers may not go there. They have heard the stories about hard money and have disqualified it as an option, even though the hard money lender can be flexible and fast in ways that traditional lenders can’t be.
The truth is, there are many myths about hard money that are keeping mortgage brokers and their investors on the sidelines. The definition of a “hard money lender” is often misused. A quick web search will uncover countless companies claiming to be hard money lenders, but their loan criteria would suggest otherwise.
Hard money parameters
The true hard money lender only cares about the value of the property in question. The moment a lender asks for tax returns and bank statements from a borrower, they fail the basic definition.
A hard money lender does not count low FICO scores, bankruptcies, foreclosures or short sales against a borrower as an automatic disqualifier. If the deal includes sufficient equity, a loan can be made. A true hard money lender also is a portfolio lender. A lender that sells mortgages to Wall Street or any other institution technically cannot be called private money.
A common misconception is that a hard money lender will allow an investor to borrow against any type of property. It is true that hard money has earned its reputation as the Wild West of oddball deals. Hard money loans are used for everything from gas stations and goat farms to strip clubs and coal mines. But there is a nuance in the definition. A true hard money lender will only make loans on nonowner-occupied commercial buildings or residential-investment properties — period.
Notably, different hard money lenders may specialize in certain property niches within these categories of nonowner-occupied commercial or residential-investment properties. As a commercial mortgage broker, you should work with someone who is familiar with the type of deal you are interested in funding.
There are several myths about a hard money loan. The first is that the only reason borrowers use hard money is because they have bad credit. It is true that blemished credit is often a driving factor behind choosing a hard money lender, but it’s not the only one. Self-employed borrowers are common hard money clients.
A traditional commercial bank may not be willing to lend to a self-employed borrower, even if that individual has good credit, a successful track record and is willing to pay a higher interest rate. Banks tend to want to see proof of consistent income over a three-year period and that hurdle is often a disqualifying factor for the self-employed borrower.
Another reason a borrower might go the hard money route is to capitalize on a time-sensitive opportunity. A traditional lender might take six weeks or more to process a loan, whereas a private lender can often accelerate the timeline and close on the loan within two weeks. This speed offers a significant advantage for a borrower in a competitive situation, since an offer with the potential of a quick close may entice a seller who doesn’t want to wait for conventional financing to close. From the seller’s perspective, a hard money loan isn’t much different from a cash offer.
Another false idea is that hard money focuses on high loan-to-value deals. In reality, it’s just the opposite. Many private commercial mortgage lenders typically will only fund up to 60 percent of the property’s value and require a 40 percent cushion of equity. Some hard money lenders are even more conservative.
It is not true that hard money deals lack due diligence. As previously mentioned, the true hard money lender may not do a rigorous financial check on a borrower. They are not concerned about the borrower’s delinquency history, so long as they have sufficient capital to pay the interest on the loan. The hard money lender will, however, do significant due diligence on the asset and its title.
The hard money lender will require an inspection and appraisal from a reputable third-party company to verify the type of construction and the property value. Typically, the appraisal will compare sales of similar assets in the same geographic area within the previous year. Depending on the size of the deal, the hard money lender may visit the property in person, do additional research on market trends or conduct stress tests on the loan’s lifetime viability.
Another common myth is that hard money loans are small-balance loans. This is a private money loan, so the minimum and maximum limits are dependent on the individual lender rather than the standards of any government agency. Loans amounts can range anywhere from $100,000 to $5 million or more. Each lender has a sweet spot.
Commercial mortgage brokers often falsely believe they have little to gain from using a hard money lender, but the true hard money lender won’t impose a cap on broker points. Another side benefit for brokers is that, compared to a traditional loan, they typically don’t need to spend as much time packaging a deal for a hard money loan.
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Hard money is about keeping things simple and that includes the application process. In most cases, an approval decision can be made in a day or two, and sometimes even by the end of the day. Not unlike a traditional loan, the hard money lender handles all the details of any deal you bring to the table, including managing the borrower’s loan application, processing and underwriting.