What is a Hard
Money Loan and how does it work?
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 at much higher
interest rates than conventional commercial or residential property
loans and are almost never issued by a
commercial bank or other deposit institution. 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.
Many hard money mortgages are made by
private investors, generally in their local areas. Usually the
credit score of the borrower is not important, as the loan is
secured by the value of the collateral property. Typically, the biggest
loan one can expect would be between 65% and 70% 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.
Loan Structure
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 remuneration.
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 carry back loan or any other subordinated loan
Interest
rates on Hard Money
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. Liberty Financials
rates are in the 10 to 15% area. 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.
Hard money points
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. The reason a borrower would pay that rate is to avoid
imminent foreclosure or a "quick sale" of the property. That could
amount to as much as a 30% or more discount as is common on short sales.
By taking a short term bridge or hard money loan, the borrower often
saves equity and extends his time to get his affairs in order to better
manage the property.
