Hard money loan
A hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by real property. Hard money loans are typically issued by private investors or companies. Interest rates are typically higher than conventional commercial or residential property loans, starting at 7.7%, because of the higher risk and shorter duration of the loan.
Most hard money loans are used for projects lasting from a few months to a few years. Hard money is similar to a bridge loan, which usually has similar criteria for lending as well as costs to the borrowers. The primary difference 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 not only an asset-based loan with a high interest rate, but possibly a distressed financial situation, such as arrears on the existing mortgage, or where bankruptcy and foreclosure proceedings are occurring.
The loan amount the hard money lender is able to lend is determined by the ratio of loan amount divided by the value of the property. This is known as the loan to value (LTV). Many hard money lenders will lend up to 65–75% of the current value of the property. What is most important to the lender is the loan-to-value (LTV) ratio. The LTV is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. Most lenders will require 10% to 15% down payment of purchase cost while financing 100% of the rehab cost. Lenders that do not require a down payment usually fund at an ARV of 70%. The ARV is the after repair value and is what a home is worth after it is fully repaired. If a home’s ARV is $200,000 and it needs $25,000 in repairs, then the 70 percent rule states the lender will finance up to $115,000. ($200,000 x 70% = 140,000 – $25,000 = $115,000.)
"Hard money" is a term that is used almost exclusively in the United States and Canada, where these types of loans are most common. In commercial real estate, hard money developed as an alternative "last resort" for property owners seeking capital against the equity in their real estate holdings. The industry began in the late 1950s when the credit industry in the U.S. underwent drastic changes.
From inception, the hard money field has always been formally unregulated by state or federal laws, although some restrictions on interest rates (usury laws) by state governments restrict the rates of hard money such that operations in several states, including Tennessee and Arkansas are virtually untenable for lending firms.
The hard money loan mortgage market has greatly expanded since the 2009 mortgage crisis with the passing of the Dodd-Frank Act. The reason for this expansion is primarily due to the strict regulation put on banks and lenders in the mortgage qualification process. The Dodd-Frank and Truth in Lending Act set forth Federal guidelines requiring mortgage originators, lenders, and mortgage brokers to evaluate the borrower's ability to repay the loan on primary residences or face huge fines for noncompliance. Therefore, hard money lenders only lend on business purpose or commercial loans in order to avoid the risk of the loan falling within Dodd–Frank, TILA, and HOEPA guidelines.
Because the primary basis for making a hard money loan is the liquidation value of the collateral backing the note, hard money lenders will always want to determine the LTV (loan to value) prior to making any extension of financing. A hard money lender determines the value of the property through a BPO (broker price opinion) or an independent appraisal done by a licensed appraiser in the state in which the property is located.
The interest rates on hard money loans are typically higher than the rates charged for traditional business loans. The interest rates could range from 10% to 18%. Despite this, such loan options are popular for their fast approvals, higher flexibility, less tedious documentation procedures and, at times, the only option for securing funds.
- Asset-based loan — a similar type of commercial loan based on real estate, indicating the loan will be based upon a percentage of the property's appraised value, as the key criteria
- Private money — refers to lending money to a company or individual by a private individual or organization
- Bridge loan — a similar type of commercial loan based on real estate
- Non-conforming loan — a loan that fails to meet bank criteria for funding
- Bhutta, Neil; Skiba, Paige Marta; Tobacman, Jeremy (March 2015). "Payday Loan Choices and Consequences". Journal of Money, Credit and Banking. 47 (2–3): 223–260. doi:10.1111/jmcb.12175.
- "Evaluating the Consumer Lending Revolution" (PDF). FDIC Office of Inspector General. 17 September 2003. Retrieved 7 February 2019.
- "Usury Law". Washington State Department of Financial Institutions. Retrieved 12 October 2015.
- "Comptroller's Handbook - Commercial Real Estate Lending" (PDF). US Department of the Treasury. Retrieved 9 September 2017.