Bad Credit? Try a Hard Money Lender
What is a Hard Money Loan?
Small businesses with less-than-perfect credit may have a hard time borrowing from traditional lenders. To meet this need, wealthy private investors and smaller investment companies have created a niche market called Hard Money Loans. These loans are asset-based and usually secured by real property. It seems, however, that new legislation may turn investors against taking the risk and offering these loans.
Background of Hard Money Loans
The hard money industry came about because of a need. Borrowers who didn’t qualify for mortgages through traditional means had nowhere to turn until savvy investors got together and offered to take the risk to help these borrowers. When the traditional lenders saw that these less-desirable loans were making a profit, they decided to jump into this lending space with offers for subprime mortgages on a wide variety of terms and interest rates. As with all trends, this one has once again turned around and the major lenders are leaving the subprime mortgage space. It seems they don’t like the increased number of foreclosures on their lending history. The hard money loan is once again king for this market.
How Do Hard Money Loans Work
Successful lending in the hard money market requires a strategy. Lenders research and know what they will be up against. They set aggressive terms to allow for the cost of foreclosure down the road. Interest rates, like all subprime loans, begin at approximately 12 percent. Minimum down payments could be as high as 30 percent. As with auto loans to poor-credit-risk borrowers, hard money lenders are fully aware that borrowers approaching them have already been turned down by everyone else. While these interest rates would appear to be pure greed, the lenders realize they will incur the cost of foreclosure on a large majority of these loans. As with all businesses, if there is no profit, the lender is not going to engage in this type of risky loan.
The rules and regulations on loans differ from state to state, so many hard money lenders shop the market to cut their risk and only do business in states that make hard money lending profitable and easy. Limiting their business to certain states helps the lenders to keep track of the value of their properties. The states with burdensome lending requirements leave certain geographic areas with no investors willing to take on credit-challenged borrowers.
Regulations on Hard Money Loan Interest Rates
The other side of burdensome regulations is limitations on interest rates investors can charge for subprime loans. These limitations were developed to define what an exorbitant interest rate is and to protect borrowers by capping interest rates and fees. These regulations prove to be double-edged swords because many investors will not loan money under these restrictions, therefore leaving many borrowers with no options for a mortgage loan. The investors who do lend money in these states set their rates at the highest rate allowed to limit exposure to the high cost of litigation.
Real Estate and Hard Money Loans
Not all borrowers who use hard money loans have bad credit. Some borrowers see hard money loans as short-term or bridge loans. A real estate investor who plans to flip a property in a short period may find a hard money loan to be easier to obtain with fewer regulations to deal with.
On the side of the lender, when working with a real estate investor, they are not looking at credit. Instead, they consider the value of the property that will be securing the loan. Hard money lenders will consider the estimated value of the property once the repairs and/or upgrades have been completed (the “after repair value” or ARV).
The Pros of Hard Money Loans
Following are the main reasons to consider borrowing from a hard money loan investor:
- Ease – Flippers and investors want to get in and out quickly, but traditional mortgage lending is generally not defined in those terms. The time processing a mortgage could cause an investor to lose the property he has his eye on. Instead of months, a hard money loan can be closed in a few weeks.
- Flexibility – Private lenders have greater flexibility to negotiate the terms of repayment, fees, and underwriting.
- Collateral – Generally, all you need to secure your hard money loan is the property. Investors, however, have freedom to accept other items and terms to secure the loan. This allows borrowers to custom design their financing.
The Cons to Hard Money Loans
Consider the following before accepting a hard money loan:
- Cost – The convenience is great, but the cost can be excessive.
- Repayment Terms – Hard money loans carry a shorter period for repayment. Be sure you can meet the terms.
Borrowers using hard money loans must educate themselves on the product, recognize that they will face limited and costly choices, and have an idea of how high the interest rate and terms may go.
Lenders must be educated on the regulations in each market they serve, and they must look for the sweet spot between what are known as profitable and predatory practices.