Hard money loan
Encyclopedia
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 shorter loan durations associated with hard money loans. 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 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.
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 carryback loan or other subordinated (mezzanine) loan
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 (see FDIC: Evaluating the Consumer Revolution).
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.
or bridge financing
.
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.
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. If you feel you have been the victim of unfair practices, contact your state's attorney general
office or the office of the state in which the lender operates.
Some private lenders will collect a prepayment penalty and some will not.
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.
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
. 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 shorter loan durations associated with hard money loans. 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
Bridge loan
A bridge loan is a type of short-term loan, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing.-Description:A bridge loan is interim financing for an individual or business until...
, which usually has similar criteria for lending as well as cost to the borrowers. The primary difference is that a bridge loan
Bridge loan
A bridge loan is a type of short-term loan, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing.-Description:A bridge loan is interim financing for an individual or business until...
often refers to a commercial property
Commercial property
The term commercial property refers to buildings or land intended to generate a profit, either from capital gain or rental income.-Definition:...
or investment
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
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
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
and foreclosure
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
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 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 lienLien
In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
position, meaning that in the event of a default
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
, 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 carryback loan or other subordinated (mezzanine) loan
History
Hard Money is a term that is used almost exclusively in the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
and Canada
Canada
Canada is a North American country consisting of ten provinces and three territories. Located in the northern part of the continent, it extends from the Atlantic Ocean in the east to the Pacific Ocean in the west, and northward into the Arctic Ocean...
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 (see FDIC: Evaluating the Consumer Revolution).
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.
Cross collateralizing a hard money loan
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
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 loansBridge loan
A bridge loan is a type of short-term loan, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing.-Description:A bridge loan is interim financing for an individual or business until...
or bridge financing
Bridge financing
Bridge financing is a method of financing, used to maintain liquidity while waiting for an anticipated and reasonably expected inflow of cash. Bridge financing is commonly used when the cash flow from a sale of an asset is expected after the cash outlay for the purchase of an asset...
.
Commercial hard money lender or bridge lender programs
Commercial hard money lenderHard money lender
Hard money lenders are lending companies offering a specialized type of real-estate backed loan. Hard money lenders provide short-term loans that provide funding based on the value of real estate that has been collateralized for the loan...
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
Hard money lender
Hard money lenders are lending companies offering a specialized type of real-estate backed loan. Hard money lenders provide short-term loans that provide funding based on the value of real estate that has been collateralized for the loan...
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.
Legal and regulatory issues
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.Commercial lending industry
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 lendingPredatory lending
Predatory lending describes unfair, deceptive, or fraudulent practices of some lenders during the loan origination process. While there are no legal definitions in the United States for predatory lending, an audit report on predatory lending from the office of inspector general of the FDIC broadly...
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. If you feel you have been the victim of unfair practices, contact your state's attorney general
Attorney General
In most common law jurisdictions, the attorney general, or attorney-general, is the main legal advisor to the government, and in some jurisdictions he or she may also have executive responsibility for law enforcement or responsibility for public prosecutions.The term is used to refer to any person...
office or the office of the state in which the lender operates.
Hard money rate
Hard Money Mortgage loans are generally more expensive than traditional sub-prime mortgages. However all mortgage loans are not necessarily considered to be a high cost mortgage. Generally a hard money loan carries additional risk that a borrower is aware of. 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). Rather than selling the property a borrower will opt to keep the loan and if a lender is willing to assume some of the risk by offering a hard money loan.Interest rate 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 . 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.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.
See also
- Asset-based loan — a similar type of commercial loan based on real estate, indicating the loan will be based upon a percentage of the properties appraised value, as the key criteria.
- Private moneyPrivate moneyPrivate money is a commonly used term in banking and finance. It refers to lending money to a company or individual by a private individual or organization. While banks are traditional sources of financing for real estate, and other purposes, private money is offered by individuals or organizations...
— refers to lending money to a company or individual by a private individual or organization. - Bridge loanBridge loanA bridge loan is a type of short-term loan, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing.-Description:A bridge loan is interim financing for an individual or business until...
— a similar type of commercial loan based on real estate. - Non-conforming loanNon-conforming loanA non-conforming loan is a loan that fails to meet bank criteria for funding.Reasons include the loan amount is higher than the conforming loan limit , lack of sufficient credit, the unorthodox nature of the use of funds, or the collateral backing it. In many cases, non-conforming loans can be...
— a loan that fails to meet bank criteria for funding. - Commercial LoanLoanA loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
— standard, broad types of loans based on commercial property value.