It isn’t uncommon to hear mortgage industry insiders refer to hard money lenders as a last resort. While this may be true to the extent that many borrowers who solicit loans from hard money lenders do so as a last resort, there are many cases in which a hard moneylender may be sought before a traditional banking institution. Let’s take a look at some scenarios where a hard money lender might be a first stop instead of a last resort.
COMMERCIAL REAL ESTATE DEVELOPMENT
Let’s say a real estate developer has sunk $10 million into a development deal and originally planned to sell units in January and would then begin to recoup their investments dollars from the project. As is the case with many such endeavors, delays may push back the beginning sales date or the project may go over budget, leaving the developer with a cash negative situation. The developer now must take out a bridge loan in order to get through his cash poor period in order to “survive” until the project begins to realize a cash positive position. With a traditional loan, the bank would not push through the loan for the borrower for four to six weeks. The developer would default on his original loan or would not have cash on hand to finish up the project. The developer needs cash right now and oftentimes needs the cash for only a two to four month period. In this scenario, a hard money lender would be the perfect partner because they can provide a loan quickly and efficiently.
Another example of a hard money scenario is a rehab investor who needs a loan to renovate run down homes that are non-owner occupied. Most banks would run from this loan because they would be unable to verify that the rehabber is going to be able to promptly sell the units for a profit — especially with no current tenants to provide rent to handle the mortgage. The hard money lender would, in all likelihood, be the only lender willing to take on such a project.
Another group who may use hard money lenders as a starting point as opposed to a last resort are real estate investors looking to “flip properties.” If an investor locates a property that they deem to be a great value, they might need quick and secure financing to take buy, renovate and sell the property quickly. Anyone looking to flip real estate does not want to hold on to the property for a long period and the short term loan from a hard moneylender will accommodate this need. The loan may also be structured as interest only, keeping the expenses low. Once the property is sold by the individual who is flipping the property, the principal is paid back and the profit is kept or reinvested into the next project.
A BORROWER IN FORECLOSURE
One final scenario of hard money involves someone who finds themselves in foreclosure. Once a homeowner falls behind on their house payments, most lenders will not provide them with a loan or restructure their current loan. Occasionally, an individual who is facing foreclosure will obtain a hard money loan to avoid foreclosure proceedings and use the time to sell the property.
The question remains why would hard money lenders loan money if a traditional bank wouldn’t even consider such a gamble. The answer is two fold. The first is that hard money lenders charge higher rates than traditional lending institutions. The second is that hard money lenders require the borrower to have at least 25-30% equity in real estate as collateral. This insures that if the borrower defaults on their loan that the lender can still recoup their initial investment.
A hard money loan is essentially a marriage between a borrower in a tough spot (either from a time sensitive perspective or due to their poor financials) and a lender who is risk adverse and is willing to take a chance for a higher return. While hard money loans may be a last resort for many, there are plenty of scenarios when hard money is the only way to go.