What is hard money? Mortgage originators often get this question from prospective clients when discussing potential financing options for the purchase of a property.
The hard money industry’s roots can be traced back to the mid-20th century when the United States economy saw a major overhaul in the way lending was presented to potential borrowers. Then, in the real estate crashes of the 1980s and 1990s, the industry endured major setbacks and was forced to reexamine itself and the manner in which it issued financing.
In recent years, the term “hard money” has changed in meaning somewhat. Prior to the subprime mortgage crisis, hard money meant just that: cold, hard cash. Essentially, it was money that belonged to a private investor that was loaned to an individual using real property as security for the loan. Some bad actors gave the term a negative connotation because of shadiness and even outright deception in their dealings with borrowers.
As the years passed, so has the negativity surrounding the term. Hard money is again considered a useful tool to be leveraged when attempting to secure financing for investment and other types of properties. Before originators suggest hard money loans to their clients, however, they should learn about the pitfalls and advantages of the programs and the lenders — just as with any other financing option — so they can efficiently and accurately represent that information to their clients.
Speed and flexibility
Hard money loans are often offered to borrowers who are enduring circumstances that make conventional loans difficult or impossible to use. Often, hard money is the best option for borrowers who are in a time crunch, because the turnaround time from application to funding is much quicker for hard money loans than traditional loans.
This quick turnaround is especially useful for borrowers wishing to purchase properties that are in high demand or subject to multiple offers. Once purchased, these borrowers can then take the time to secure long-term conventional financing — with the assistance of the originator who helped them secure the property in the first place.
In addition to being fast, hard money loans also are highly customizable. Contrary to the one-size-fits-all model of traditional lending, many characteristics of hard money loans can be tailored to fit the individual needs of a borrower, including repayment terms and underwriting requirements. Hard money can be the best option for borrowers who are already subject to multiple mortgages on various properties, for example, so they can be useful to real estate investors who often deal with multiple investment properties.
“ In exchange for not scrutinizing a borrower’s credit profile, the hard money lender will ask for more borrower equity to secure the loan. ”
Finally, hard money loans afford a competitive edge to auction-attending borrowers. The typical scenario at a real estate auction involves several potential cash buyers competing for properties. With hard money loans, the competition is expanded to include buyers using financing. These buyers can leverage their financing to participate and ultimately win an auction property. Hard money loans also can help these borrowers renovate or maintain the property until they choose to put it up for sale.
Originators who wish to work with real estate investors will need to research hard money lenders in their area to find the best options for their investor clients. As time is almost always of the essence in these deals, that research needs to be done ahead of time, so the deal can go through quickly when it is brought to the originator.
Costs and concerns
As with all things, however, nothing comes for free. Hard money lenders are willing to extend financing to borrowers who do not qualify for conventional loans, which makes their investment inherently riskier. To account for this risk, hard money lenders charge interest rates that are often much higher than those of conventional loans. An originator’s clients will need to understand this up front.
In addition, hard money lenders are more interested in the value of the property than the credit profile of the borrower, which places much more scrutiny on the property. Hard money lenders often are much more conservative when placing a value on a subject property than a conventional lender. This lower property value ultimately translates into lower loan amounts because of loan-to-value (LTV) ratios — which also are generally lower for hard money loans than for conventional loans.
Lower values and lower LTVs means that hard money lenders require substantially larger downpayments from an originator’s clients. Where conventional borrowers often can find financing with anywhere from a 3 percent to 10 percent downpayment, a hard money borrower often must make a 25 percent to 30 percent downpayment — or higher — to be approved for a hard money loan.
This, again, goes back to the risk level that the lender is enduring to issue the loan. Hard money lenders are in business to make money and, as such, they will pass their risks on to their borrowers. In exchange for not scrutinizing a borrower’s credit profile, the hard money lender will ask for more borrower equity to secure the loan. They want to make sure the borrower is properly motivated and has enough skin in the game to stick around, rehabilitate and resell the property.
Another factor that originators must consider before suggesting hard money loans to their borrowers is the repayment time frame. Where conventional loans have terms of 15 years to 30 years, generally, the loan terms on hard money loans usually last no more than a few years.
Hard money loans are intended to be used as short-term loans to facilitate purchases and subsequent sales of properties, or as a financing “bridge” until a longer-term conventional loan can be closed to pay off the hard money loan. Hard money lenders are not in the business of long-term investments. The majority of them are interested in making profits on the quick turnaround of their capital, which is another reason for the higher interest rates.
Finally, in many states, hard money lenders are not highly regulated, besides usury laws, so they often can charge a borrower more than usual to originate the loan. This makes hard money loans much more expensive to obtain than conventional loans. Originators should inform their borrowers of this extra cost at the beginning of the process and help clients investigate and calculate the risks and benefits of using hard money to handle their particular financial situations.
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Hard money loans are now viewed as just another tool in the belt of the originator, which can be useful in many specific situations for certain borrowers. As mortgage professionals, the best thing originators can do is to become fully informed about all the options they can potentially present to prospective clients, including hard money loans.
Once those options are presented and originators help their borrowers make informed decisions, they then must concentrate on delivering the best possible service in connection with those requests. Borrowers who are aware of the risks and potential consequences of their decisions — as well as the benefits to them — will translate into satisfied clients who will then turn into repeat customers and excellent sources of referrals.