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A hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by the value of a parcel of real estate. Hard money loans are typically issued by private investors or companies. Interest rates are typically higher than conventional commercial or residential property loans because of the higher risk taken by the lender. Most hard money loans are used for projects lasting from a few months to a few years. Hard money is similar to a bridge loan, which usually has similar criteria for lending as well as cost to the borrowers. The primary difference is that a bridge loan often refers to a commercial property or investment property that may be in transition and does not yet qualify for traditional financing, whereas hard money often refers to not only an asset-based loan with a high interest rate, but possibly a distressed financial situation, such as arrears on the existing mortgage, or where bankruptcy and foreclosure proceedings are occurring.
The qualifying criteria for a hard money loan varies widely by lender and loan purpose. Credit scores, income and other conventional lending criteria may be analyzed. However, most hard money lenders primarily qualify a loan amount based on the value of the real estate being collateralized. Typically, the biggest loan one can expect would be between 65% and 75% of the property value. That is, if the property is worth $100,000, the lender would advance $65,000 - $70,000 against it. This low LTV (loan to value) provides added security for the lender, in case the borrower does not pay and they have to foreclose on the property.
A hard money loan is a species of real estate loan collateralized against the quick-sale value of the property for which the loan is made. Most lenders fund in the first lien position, meaning that in the event of a default, they are the first creditor to receive renumeration. Occasionally, a lender will subordinate to another first lien position loan; this loan is known as a mezzanine loan, a second lien or a junior lien.
Hard money lenders structure loans based on a percentage of the quick-sale value of the subject property. This is called the loan-to-value or LTV ratio and typically hovers between 60 and 70% of the market value of the property. For the purpose of determining an LTV, the word "value" is defined as "today's purchase price." This is the amount a lender could reasonably expect to realize from the sale of the property in the event that the loan defaults and the property must be sold in a one- to four-month timeframe. This value differs from a market value appraisal, which assumes an arms-length transaction in which neither buyer nor seller is acting under duress.
Below is an example of how a commercial real estate purchase might be structured by a hard money lender:
65% Hard money (Conforming loan)
20% Borrower equity (cash or additional collateralized real estate)
15% Seller carryback loan or other subordinated (mezzanine) loan
Hard Money is a term that is used almost exclusively in the United States and Canada where these types of loans are most common. In commercial real estate, hard money developed as an alternative "last resort" for property owners seeking capital against the value of their holdings. The industry began in the late 1950s when the credit industry in the U.S. underwent drastic changes.
The hard money industry suffered severe setbacks during the real estate crashes of the early 1980s and early 1990s due to lenders overestimating and funding properties at well over market value. Since that time, lower LTV rates have been the norm for hard money lenders seeking to protect themselves against the market's volatility. Today, high interest rates are the mark of hard money loans as a way to compensate lenders for the considerable risk that they undertake.
In some cases, the low loan-to-values do not facilitate a loan sufficient to pay off the existing mortgage lender, in order for the hard money lender to be in first lien position. Because a security interest in the property is the basis of making a hard money loan, the lender usually always requires first lien position of the property. As an alternative to a potential shortage of equity beneath the minimum lender Loan To Value guidelines, many hard money lender programs will allow a "Cross Lien" on another of the borrowers properties. The cross collateralization of more than one property on a hard money loan transaction, is also referred to as a "blanket mortgage". Not all homeowners have additional property to cross collateralize. Cross collateralizing or blanket loans are more frequently used with investors on Commercial Hard Money Loan programs.
Commercial hard money is similar to traditional hard money, but may sometimes be more expensive as the risk is higher on investment property or non-owner occupied properties. Commercial Hard Money Loans may not be subject to the same consumer loan safeguards as a residential mortgage may be in the state the mortgage is issued. Commercial hard money loans are often short term and therefore interchangeably referred to as bridge loans or bridge financing.
Commercial hard money lender and bridge lender programs are similar to traditional hard money in terms of loan to value requirements and interest rates. A commercial hard money or bridge lender will usually be a strong financial institution that has large deposit reserves and the ability to make a discretionary decision on a non-conforming loan. These borrowers are usually not conforming to the standard Fannie Mae, Freddie Mac or other residential conforming credit guidelines. Since it is a commercial property, they usually do not conform to a standard commercial loan guideline either. The property and or borrowers may be in financial distress, or a commercial property may simply not be complete during construction, have its building permits in place, or simply be in good or marketable conditions for any number of reasons.
Some private investment groups or bridge capital groups will require joint venture or sale-lease back requirements to the riskiest transactions that have a high likelihood of default. Private Investment groups may temporarily offer bridge or hard money, allowing the property owner to buy back the property within only a certain time period. If the property is not bought back by purchase or sold within the time period the commercial hard money lender may keep the property at the agreed to price.
Traditional commercial hard money loan programs are very high risk and have a higher than average default rate. If the property owner defaults on the commercial hard money loan, they may lose the property to foreclosure. If they have exhausted bankruptcy previously, they may not be able to gain assistance through bankruptcy protection. The property owner may have to sell the property in order to satisfy the lien from the commercial hard money lender, and to protect the remaining equity on the property.
From inception, the hard money field has always been formally unregulated by state or federal laws, although some restrictions on interest rates (usury laws) by state governments restrict the rates of hard money such that operations in several states, including Tennessee and Arkansas are virtually untenable for lending firms.
Thanks to freedom from regulation, the commercial lending industry operates with particular speed and responsiveness, making it an attractive option for those seeking quick funding. However, this has also created a highly predatory lending environment where many companies refer loans to one another (brokering), increasing the price and loan points with each referral.
There is also great concern about the practices of some lending companies in the industry who require upfront payments to investigate loans and refuse to lend on virtually all properties while keeping this fee. Borrowers are advised not to work with hard money lenders who require exorbitant upfront fees prior to funding in order to reduce this risk. Those who feel they have been the victim of unfair practices should contact their state's Attorney General's office or the office of the state in which the lender operates.
Hard Money Mortgage loans are generally more expensive than traditional sub-prime mortgages. Private investors are generally only willing to create hard money loans in return for a very high interest rate (often about 11.5% plus five points for residential home purchases).
The rate is not dependent on the Bank Rate. It is instead more dependent on the real estate market and availability of hard money credit. As of 2008 and for the past decade hard money has ranged from the mid 12%–21% range . When a borrower defaults they may be charged a higher "Default Rate". That rate can be as high as allowed by law, which may go up to or around 25%–29%. Some private lenders will collect a prepayment penalty and some will not.
Points on a hard money loan are traditionally 1 to 3 more than a traditional loan, which would amount to 3 to 6 points on the average hard loan. It is very common for a commercial hard money loan to be upwards of four points, and as high as 10 points. There are as many reasons a borrower would pay rates this high as there are borrowers. Almost all reasons have something to do with the speed or lack of credit requirements that are beneficial characteristics of most hard money loans. Sometimes there is an opportunity to purchase a property at a profitable discount if the buyer can raise the cash quick enough. Sometime personal or business needs require cash quickly or money is needed by a borrower who would not other wise be able to get funds due to his credit or existing debt not qualifying him for a conventional mortgage.
All hard money borrowers are advised to use a professional real estate attorney to assure the property is not given away by way of a late payment or other default without benefit of traditional procedures that would require a court judgment.