One of the most often made mistakes by inexperienced brokers is thinking that hard money loans are for properties on which no other lender would ever make a loan. We call this the Loan for All Occasions. Just because a borrower can’t get conventional financing doesn’t mean their situation is right for hard money. Sure they may “need” hard money, but don’t confuse “need” with what is actually possible to finance.
There are many reasons why conventional lenders will not finance a project:
- Borrower has bad credit
- Property is in declining value market
- Borrower does not have good financials or cash reserves
- Property needs too much rehab or construction work
- Residential property zoned commercial, or vice versa
There are many reasons borrowers choose to use hard money, including:
- Quick underwriting, approval, and funding process
- Less restrictive credit requirements
- Easy documentation process
- Ability to be flexible with valuation
- Ability to work with corporate entities, trusts, and other legal structures
Most good hard money real estate loans are made on properties that would probably pass muster conventionally, except for one or two details. Those are deals that make sense for everyone. For instance, maybe your client has good financials, can show a strong profit, has a great exit strategy, but he doesn’t have great credit.
That’s a good hard money loan. Another borrower might have great credit, good cash reserves, and a ton of experience, but she might need a slightly higher LTV than what a conventional lender might be willing to accept. That too is a great potential hard money scenario, especially if she has cross collateral to throw into the mix.
The point is, there’s something there for a hard money lender to work with; and the beginnings of a creative deal.
The Lost Cause
All too often hard money becomes associated with the lost cause – deals that just aren’t doable. For example, a newbie borrower who grabs onto a property he thinks is a good deal just because the purchase price is low compared to other properties in the area, without any regard for the cost of rehab and its relation to the after repair value. You’d be surprised how many deals we see where borrowers ask for more money in loans than the property will be worth when it is completely fixed. That deal just isn’t doable.
Hard money loans are asset based loans, which means the key underwriting factor will be asset value. That doesn’t mean a hard money lender will make a loan on just any property even when the value is there. Without getting to far into underwriting methodologies, there are other criteria private lenders look at when determining whether to make a loan on a specific piece of real estate.
For instance, while the property should be able to support the loan on its own (positive cash flow), private hard money lenders still want to know that the borrower has some cash reserves to pull the project through the lean times. This is especially true for borrowers completing rehab projects. Lenders won’t make a loan if the borrower can’t complete the rehab work. It just doesn’t make sense to lend a portion of after repaired value if the borrower can’t complete the repairs to get the property to the point where it is actually worth the after repair value.
It’s also the reason why the same borrower doesn’t qualify for many conventional loan products. The property may fit the guidelines, but the borrower’s own financials don’t fit, hence the loan never gets made. What’s amazing is how the borrower doesn’t recognize he is the weak link in that scenario. The really unfortunate thing is that there is always an inexperienced broker willing to take on that deal and shop it all over the country to anyone willing to look at it. Sometimes that broker will convince the borrower to spend money on underwriting or due diligence fees with unscrupulous lenders. Ultimately, when that deal falls, the borrower loses a property, the broker wastes his time, and no one makes any commission, let alone any profit.
Hard Money Loans are not the Loans for All Occasions!
I believe that everyone has at least one stellar deal in them, and if your client doesn’t have the resources to pull it off, you are better served partnering her up with a more financially secure borrower than to shop that deal the way it is.
In the hard money business, money follows money. If the client can invest a little bit of her own money there will always be a lender to meet her half way. Next time, instead of shopping a deal for months only to watch it die a million deaths, take a few weeks to network with other investors, partner your client, and get the loan she needs alot quicker.
You may be reading this article thinking “wow, he has a cynical view of hard money.” That’s not my intention. Rather, I hope this information serves to show borrowers that there is a distinct thought that goes into the underwriting of hard money real estate loans. So too, hard money brokers must practice discretion, and restrict the deals he will and will not take on.
For the most part, brokers make money when deals close, and not sooner. Learning to say no will be the best thing you ever do. It’s counterintuitive, but it works, and your clients will appreciate your honesty and your effort much more than broken promises and wasted time.