The “Hard Money” Business: If you need a loan real bad, we have a real bad loan!
If you’re trying to buy or refinance a property and you’ve been given the cold shoulder by banks, where do you turn?
If you’re lucky enough to have wealthy friends or relatives willing to loan you money, and you don’t mind getting into a business relationship with them, great! But remember: Things could get ugly, and relationships could be STRAINED, to put it mildly.
For some of our clients, the best option is HARD MONEY: funds from private non-bank sources. Most of these funds are provided by private citizens, and the loans are arranged by “hard-money” brokers.
Here’s how the business works: Let’s say you’re Daddy Warbucks, and you have some extra cash lying around. If you leave it in the bank, it may earn 1%. You could invest it in the stock market and earn 5% if you’re lucky. But if you’re willing to accept a little more risk, you could earn 8% or 9% by making real estate loans to other private individuals.
It’s the hard money broker’s job to find these investors, match them up with borrowers, draft the necessary notes and deeds, and make sure there’s a good chance the money will be repaid by examining the borrower’s credit, assets, income, and property. Then the broker will collect monthly payments from the borrower and give the investor his or her share.
How does the broker get paid? Typically through up-front points paid by the borrower at closing. Sometimes, the broker may also share in the monthly interest earnings or charge a servicing fee.
What’s the risk to the investor? Remember that the borrowers have been turned down by traditional banks, possibly due to bad credit, insufficient income, or non-standard properties. But banks often reject good borrowers who don’t fit their cookie-cutter guidelines. These borrowers are the hard-money lender’s ideal candidate. Since these investors don’t plan to sell their loans to banks, they don’t have to follow generally-accepted underwriting rules.
In my 27 years in the mortgage industry, I’ve seen countless examples of good borrowers running afoul of overly punitive bank underwriting guidelines:
- The professional athlete with $6 million in his checking account who was turned down for a $400,000 loan because his contract for the upcoming season hadn’t been officially renewed yet.
- The millionaire investor who owned 30 houses who was turned down for a refinance because he had “only” $500,000 in liquid reserves.
- The highly-regarded high-tech VP who’s refinance request was rejected by a bank because (despite 25 years in the industry) he had been on his new job only 12 months. According to the underwriter, he was a “job hopper” and hence “unreliable”.
Hard money lenders love it when banks turn down good people. Their business has been booming since the 2008-2009 mortgage meltdown forced traditional lenders to tighten their guidelines. But to protect themselves, they want to make sure there’s at least 30% equity in the property. That way, there’s enough cushion to absorb costs if they have to take the property by foreclosure and sell it.
And as further protection against perceived risk, the rates are high – at least twice as high as traditional mortgage rates - and with high up-front points and fees.
But the cost of hard-money financing could be a bargain when compared with the opportunities they make possible.
Let’s say you can pick up a distressed property at a below-market price of $600,000, sink $100,000 into it for repairs, and sell it for $800,000 three months later. Your bank won’t touch you because you had a loan modification three years ago, but your friendly neighborhood hard-money broker will gladly charge you 9% on a $420,000 loan with three points up front ($12,600). After 3 months, this loan would have cost $22,050 in interest and points, and you’re left with a profit of $77,950.
As painful as paying 9% and 3 points seems, it’s better than the alternative: being forced to walk away from a great opportunity.