In a previous post at the Rules of Thumb blog from MoneyThumb, we discussed what a hard money loan is. Here is a quote from that article, "Loans are commonly referred to as “hard-money” loans because lenders use a “hard asset”--traditionally, real estate--to secure the loans. Because private lenders often are focusing heavily on a hard asset with a low loan-to-value ratio, many lenders are able to look past some credit issues. In other words, hard-money lenders rely on a borrower’s equity to act as their security. Hard-money lenders are privately funded and not regulated like traditional banks."
Now that we are clear on what exactly a hard money loan is, what are some reasons a borrower might choose a hard money loan?
1. A real estate asset is not bringing in cash-flow.
Conventional lenders typically underwrite real estate loans based off a property’s operating statements, cash flow and net operating income (NOI). Because the asset does not produce income or does not produce enough income, the risk to a lender is understandably higher. Hard money lenders are not restricted to a debt-service-coverage (DSC) analysis. They can look at the value of the underlying asset more than the income it brings in to determine their lending capability.
2. The borrower needs a higher loan amount.
Gap financing lenders have the flexibility to offer higher leverages in comparison to conventional lenders, who are restricted by their guidelines and underwriting parameters. That’s not to say hard money lenders don’t have their own lending limits. They do have loan-to-value (LTV) limits as well. But if the value of the assets securing the loan can support it, there is a greater chance of getting higher loan dollars than through a bank that tends to be more conservative.
3. Quick closing needed.
When issuing loans, conventional lenders usually advertise a 45-90 day loan process, from loan application to loan closing. Hard money lenders need much less documentation and don’t require the same level reviews to close a loan. This streamed line approach cuts the closing time significantly.
4. Cheaper than using equity.
A loan with a 10-18% interest rate and 2-4 points upfront is generally not considered cheap money. However, that can still be substantially less expensive than what it would cost to bringing in equity from a joint venture partner or another equity source. In addition to interest on the money, an equity partner would likely want some sort of ownership of the asset. By choosing a hard money lender, the borrower will come out better than involving equity that might be compromised.
5. Conventional lender underwriting guidelines.
As mentioned above, conventional lenders have specific lending parameters and underwriting guidelines. These guidelines are based on factors such as asset class, loan size, location, and neighborhood makeup if real estate property is being used as equity, and market trends, just to name a few. In contrast, a hard money loan provider is not restricted to any specific set of guidelines. They are free to lend on any project they see fit.
6. Need for short term financing.
By definition, hard money loans, also sometimes referred to as bridge loans, are short term loans. It often occurs that a borrower may have an agenda then only requires financing for a short period of time. Hard money loans typically have 1-year maturities of up to 3 years.
7. Borrower’s credit score.
A less than stellar credit score is often the reasons borrowers choose to obtain a hard money loan. Hard money lenders almost always do not have the same credit score requirements as banks and other traditional lenders. Choosing a hard money lender allows a borrower breathing room beyond their credit score.
8. Challenges with Assets
Oftentimes, the borrower may be the perfect candidate for a conventional loan, but the assets they are offering as equity may not be ideal. For instance, say the borrower wants to use a piece of real estate as collateral, but the property may have environmental issues, may be located in a market that is not established or is less than desirable. A hard money lender is a laxer in their requirements as far as assets are concerned than a traditional lender.
The Rules of Thumb blog from MoneyThumb thinks these cover well the reasons why a borrower might choose the avenue of a hard money loan. If you know of other reasons leave us a comment below and we will see if we should add it to our list.