Explaining Hard Money Lenders - Part 2

Part 2

In Part 1 of Explaining Hard Money Lenders, we discussed the differences between institutional, or traditional, lenders and nontraditional (also known as non-conforming or hard money) lenders. We saw that hard money lenders provide a necessary service in the real estate market. But we could not overlook that this service comes at a fairly hefty premium. Let’s continue by taking a look at how and why hard money lending came about.

Prospective borrowers’ credit applications began being scored quantitatively (or, measured in numerical terms) in the 1950s. Of course, when this happened, qualification cutoffs were established. People with lower scores could not obtain the credit that they needed. Therefore, a new market was created. As with any other investment, the higher risk due to lending to less creditworthy applicants allowed higher rates and fees to be imposed by the lenders. People with money to invest saw this market as a potentially very lucrative one, and the service began in earnest in the late 1950s.

The industry was hurt considerably with the real estate crashes of the 1980s and early 1990s due to lenders overvaluing and funding properties at more than their market prices. When real estate values fell, lenders lost substantial amounts of their investments. This, in large part, explains the lower loan-to value percentages given by hard money lenders which are the norm today.

The costs of hard money can be quite prohibitive. Terms can vary greatly from lender to lender. Interest rates normally range from 12- to 18%, with anywhere from 2- to 10 points being charged. The average period of a hard money loan is from six months to about 5 years; however, longer amortized terms are possible with balloon payments due after several years. Why would anyone pay such exorbitant fees? Well, it must be remembered that hard money loans are not meant to be long-term financing solutions. They are typically used as bridge loans, short-term loans to provide a borrower with quick funds for a closing or to temporarily solve a problem. They are meant to give the borrower time to fix up the property and find a buyer, or to fix his or her credit in order to procure more suitable long-term financing.

One of the advantages of hard money lenders is that they are not restricted by institutional rules from financing any types of properties. There are lenders that prefer to make loans to residential homeowners or homebuyers, as well as those who favor non-owner occupied homes or commercial properties. Some require considerably more paperwork in their applications than do others. Some will review an applicant’s credit, others won’t. Their lending criteria can be as varied as their own individuality and risk comfort levels allow them to be. Raw land, nursing homes, shopping malls, hotels and motels, gas stations, movie theaters or duplexes can all be funded with hard money. Institutional lenders may balk at many of these, especially without the presence of an extremely financially-strong borrower.

Hard money lenders are particularly useful for real estate investors. Many times lucrative deals can present themselves quickly in the commercial investment property arena, and hard money lenders allow investors to move quickly to purchase the property. Where traditional lenders may take anywhere from two- to six months to fund a loan, especially when dealing with commercial ventures, hard money lenders can enable an investor to make an offer and close on the transaction in as little as two weeks.

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