Top 8 Reasons Borrowers Use A Hard Money Loan
Oct 05, 2016
The United States has enjoyed a historical run of low interest rates over the past few years. This has created a borrowers market. For a majority of commercial real estate financing projects, conventional banks will lend at favorable rates of between 3-5%, depending on the project type. A borrower is able to enjoy permanent financing that has a lower borrowing costs. In turn, the lender receives a steady and predictable rate of return from the borrower.
But not every real estate project requiring financing fits into conventional lender guidelines and limits. In these situations, the perceived lending risks increases for a conventional lender as their willingness to lend decreases substantially. These real estate projects that are not ‘cookie-cutter’ deals require a borrower to obtain financing through alternative financing sources, such as Hard Money Loans.
Commercial Hard Money Loans
have higher up-front costs and higher loan interest rates. It might make a conventional borrower wonder why a lender would offer loans in the 10-18% interest range when there are lower cost options available for a borrower to take. After all, consumers are being bombarded everyday with advertisements that are offering market low rates and attractive terms. Never-the-less, there exist an established sector of the real estate market that caters to hard-money loan borrowers. In up-markets and down-markets, hard money lending sources have played their part in keeping the real estate market moving forward.
So, Why Would A Borrower Accept The Higher Rates Of A Hard Money Loan?
Here is a list of the common reasons:
The Real Estate Asset Is Not Cash-Flowing Or Does Not Support The LoanConventional lenders typically underwrite their commercial 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 understandable 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. Because they are lending private monies, those providing hard money loans are not bound by standard underwriting procedures.
Borrower Needs A Higher Loan AmountGap 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 lender’s don’t have their own lending limits. They do have loan- to-value (LTV) limits as well. But if the value of the real estate property supports the loan, there is a greater chance of getting higher loan dollars than through a bank that tends to be more conservative.
Quick Closing NeededWhen issuing commercial real estate loans, conventional lenders usually advertise a 45-90 day loan process, from loan application to loan closing. Conventional lenders can promise to ‘try’ and get things done quicker. But ‘trying’ may not be enough security for a commercial real estate buyer. The buyer may not want to risk the opportunity (and their earnest money) to buy a property by their purchase contract closing date. 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.
Cheaper Than Using EquityA loan with a 10-18% interest rate and 2-4 points up front 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 other equity source. In addition to interest on the money, an equity partner would likely want ownership of the project as well (not to mention decision rights, too!). This would significantly change a real estate owner’s return on investment.
Strict Conventional Lender Underwriting GuidelinesAs mentioned, conventional lenders have their specific lending parameters and underwriting guidelines. These guidelines are based on factors such as: asset class, loan size, location, neighborhood makeup, and market trends, just to name a few. Some lenders have been known to tweak their requirements a little for certain borrowers who have an extensive borrowing history with them or if they can agree to establish notable deposit relationships and/or operating accounts. But for the most part, their guidelines are set. 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.
Need For Short Term FinancingBy definition, hard money loans, also sometimes referred to as bridge loans, are short term loans. A commercial real estate owner may be looking to develop a property or they may have an agenda then only requires financing for a shorter period of time. Hard money loans typically have 1 year maturity’s up to 3 years. Interim financing sometimes does not have a prepay for early prepayment.
Borrower(s) CreditFor commercial real estate loan borrowers, having a credit score below 650, can eliminate most conventional lenders as lending options. Items that adversely affect a borrowers credit include: late payments, tax liens, bankruptcies, foreclosures, mechanic liens, court enforced notices, too many credit inquiries, and high levels of debt. Although the borrower’s credit may work for a conventional lender, the project and other factors a borrower brings to the table can still get them funded with a hard money loan.
Property ChallengesThe loan applicant(s) may be perfect candidates, but the project or commercial property may not be ideal. For instance the property may have environmental issues that are evidenced in a Phase I or Phase II report, an appraisal report, or site visit. The project may be located in an unestablished market, or changing neighborhood. The owner may be looking to reposition a property that could be outside a conventional lenders comfort zone. Or there can be issues in receiving the proper permits from the local government. All these property challenges mentioned, and others that were not, can be factors a hard money lender could get comfortable with if there are other compensating factors that can make issuing the loan attractive.
Commercial Hard Money loans have an established and necessary niche within the real estate market because there will always be good borrowers and projects worth funding, which don’t fit neatly into standard underwriting guidelines. A borrower can expect the higher the associated risk for a lender, the higher the lending interest rate. But with the right project and circumstances, there is hard money lender willing to lend.