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Hard money lenders are lending companies offering a specialized type of real-estate backed loan. They lend short-term capital (also called bridge loans) that provide funding based on the value of the real estate acting as collateral. Hard money lenders tend to focus on the value of the collateral property rather than the borrower's ability to repay based on their own personal income or assets, as is common with other lenders. Hard money lenders typically charge much higher interest rates than banks because they fund deals that do not conform to bank standards such as verification of borrower's income, assets, or credit score.
Hard money lenders will offer a range of requirements on how much they will lend (loan to value), what types of real estate they will lend on (commercial, residential, multi-family, land) and minimum and maximum loan sizes. Hard money lenders that lend on residential property must be licensed through their state regulatory agency and through the National Mortgage Licensing System (NMLS). Borrowers should verify the lenders license through the NMLS in order to prevent problems at closing, as many states require the lender's license number to be listed on the loan documents. Not having the license number on the loan documents could prevent the loan from closing.
Hard money loans are more expensive than traditional loans because they are not based upon traditional credit guidelines which protect investors and banks from high default rates. As hard money lenders may not require the income verification that typical lenders require, they may experience higher default rates (and, thus, charge a higher rate of interest). Individuals and companies may opt to take a hard money loan when they cannot obtain typical mortgage financing because they do not have acceptable credit or other documentation typically required by a conforming loan. However, federal law now requires that all hard money lenders verify "ability to repay" - per the Dodd-Frank Act of 2010 - on all residential property loans. In order to prove "ability to repay", licensed hard money lenders will also be asking for documentation of income. This documentation may not be as stringent as the documentation required for a conventional loan, and the hard money lender may look at the numbers differently, but more than likely, borrowers will still have to provide a tax return and bank statement.
Term of loan: hard money loans are typically of a shorter term than conventional loans, although you can find terms of up to 10 years depending on the lender. Because of the shorter term, borrower should ensure that they have the resources necessary to pay off the loan when it becomes due.
Prepaid interest: per the Dodd-Frank Act of 2010, it is illegal for a borrower who will be occupying the residential property to pay more than two months of interest in advance. That means that the lender cannot require that you pay for a full year of payments in advance - called "prepaid interest". However, the lender can require this on a commercial property loan.
Collateral refers to the property that is being used to secure the loan. This can include residential, multi-family, commercial, or raw land properties. However, it sometimes includes other assets of the individual or business borrowing the hard money. In many cases a hard money lender will offer a smaller loan size based upon a lower "Loan to value ratio". This means they may lend a lower percentage of the property value. Therefore it is common for real estate investors to offer additional real estate as collateral in order to obtain a larger loan amount. This is known as cross-collateralization.
Several states' usury laws, including Tennessee and New Jersey, prevent hard money lenders from charging higher interest rates. Regulation of hard money not only differs by state, it differs by the type of the borrower: business borrower or consumer borrower. Consumers (or owner occupants) generally have additional protections in individual states and also under the Dodd-Frank Act. Some of the most aggressive loan terms are issued by commercial hard money lenders on commercial properties. In addition, the type of property being lent upon may also be a factor in determining if state usury laws allow for legal hard money lending.
Commercial hard money is issued to a business entity or individual signing on behalf of a business entity or corporation. It can be secured against a commercial property or residential investment property. It can also be secured against a residence in conjunction with a business property as a means of obtaining additional collateral for the lender. That type of additional security is referred to as a blanket mortgage. The sources of asset based commercial hard money loans are generally the following:
Loan terms vary from hard money lender to hard money lender. Borrowers should be sure to carefully review the lender's interest rate, prepayment penalty, loan to value, default rates, APR, work out solutions, points (fees for the loan), etc. For example, a private individual may offer a lower interest rate than a hard money lending company, but may be unwilling to offer a work out plan, in the event the loan becomes delinquent, or a hard money lending company may offer a lower interest rate, but demand a high pre-payment penalty fee, costing the borrower more money if they decide to sell or refinance the loan within one to five years. Because these terms are not standardized across the industry, it is important to check with each lender and ask them for their "terms", as well as how long it will take them to close a loan.