High Interest Rates are Charged on Hard Money Loans
Hard money loans are specific types of asset-based loan financing in which a borrower receives the loan funds which are secured by the value of a real estate property. Hard money loans though typically carry much higher interest rates than conventional commercial or residential property loans and are almost never issued by a commercial bank or other money deposit institutions. A hard money loan is similar to a bridge loan which usually carries the same criteria for lending and both loan types practically cost the same when availed of by the borrowers.
The primary difference between the two types of loan 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 an asset-based loan with a high interest rate, but possibly to be used to rescue one’s distressed financial situation, such as arrears on the existing mortgage, or where bankruptcy and foreclosure proceedings are likely to occur. This is probably the reason why loans of this type are called hard money loans since the borrower takes out the loan under difficult circumstances.
Many hard money loans are given by private investors, generally in their local areas. The credit score of the borrower of the hard money loan is not so important, as the loan is secured by the value of the property offered as its collateral. Typically, the maximum loan to property value ratio is 65-70%. If the collateral property is worth $100,000, the lender would advance $65,000-70,000 against it. This low loan to value ratio (LTV) provides added security for the lender, in case the borrower does not pay and the lender has to initiate foreclose proceedings on the property. At least the money he exposes to the borrower is thirty percent less than the money he stands to realize if he sells the foreclosed property. This is basically also how lenders of hard money loans make their profits in their business.
Lenders of hard money loans usually fund the loans in the first lien position, meaning that in the event of a default in the loan repayment, they are the first creditors to receive remuneration. By following this procedure lenders are playing safe in the exposure of their money because the lien they hold assures them that they can get their money back. Occasionally, a lender will subordinate himself to another first lien position loan; the loan of this kind is known as a mezzanine loan or second lien, but still favorable to the second lender. He can still make a safer profit as the property in the first lien may be worth so much that he still can have his share of the sales proceeds of the property that is foreclosed.
Hard money lenders structure the loans they offer based on a percentage of the quick-sale value of the subject property. This is the loan-to-value or LTV ratio and that is about 60-70% of the market value of the property. For the purpose of determining what the LTV should be, the word "value" is defined as "today's purchase price" of the property in question. This is the amount a lender could reasonably expect to realize from the sale of the property in the event that the borrower of the loan defaults in his payments and the property must be sold in a one- to four-month timeframe. This value differs from a market value appraisal, where neither the buyer nor the seller is acting under duress.
Hard money loans are loan types which are most common in the United States and Canada. In the field of commercial real estate business, hard money loans developed as an alternative "last resort" for property owners who are seeking capital against the value of their holdings. The hard money loan industry had its beginnings in the 1950s, during the years when the credit industry in the US underwent drastic changes. Since then the industry has developed and it is now common practice in the world of real estate.
The hard loan money industry suffered severe setbacks during the real estate crashes of the early 1980s and early 1990s due to lenders over-estimating and funding properties at well over their market values. Since that time, lower LTV rates have been the norm followed by hard money lenders who sought to protect themselves against the market's volatility which happens so often. Today, high interest rates are normal in hard money loans. This is the way lenders try to make their profits on the money they expose considering the considerable risk that they undertake in these types of loans.
AS to how hard money lenders now are faring in their business due to the current recession, not much is known as of now. Likely they are also encountering difficulties like all other sectors in the economy, considering that business transactions now are often interconnected, and adverse conditions in one sector could have some negative effects too on others. Considering that these kinds of loans are just very close to the real estate business, hard money loan lenders too may be are just doing their best to survive in the crisis.
In some cases, the low loan-to-values existing do not make a hard money loan sufficient to pay off the existing mortgage lender, in order for the hard money lender to be in first lien position. As a lender’s first concern is the security of his money to be loaned out, he usually always requires first lien position of the property. A borrower thus has to produce a property of higher value so he can avail of the hard money loan he needs.
As an alternative to a first lien requirement many hard money lenders may allow “Cross Lien” on another of the borrower’s properties. The practice of cross collateralization of more than one property on a hard money loan transaction is also referred to as a "blanket mortgage". This is not usual however as not all homeowners have additional property to cross collateralize. Cross collateralizing or blanket loans are more frequently used by investors on commercial hard money loan programs.
