What’s a Hard-Money Loan, and Do I Want One?

Most of us don’t have several hundred thousand dollars in cash lying around, so when we want to purchase real estate (or invest in a business or embark on other expensive endeavors), we need a loan.

Conventional bank loans require borrowers to follow strict guidelines regarding proof of income and creditworthiness. This works well for those with regular jobs; however, some folks have assets, but not income, and therefore, do not qualify for conventional loans. This is when they come to lenders like me, because I am willing to accept real estate as collateral for a loan.

Private loans like this are referred to as hard-money loans or equity loans, and while their terms are not as favorable as conventional bank loans’, they provide an important option in less-than-conventional circumstances. Hard-money loans can range from short term (a few months) to long term (50 years or more). Typically, they are in the five-year range.

As I implied above, if you can get a bank loan, you should, because the priciest bank loan will be less expensive than the cheapest hard-money loan. Interest rates can be twice as high and loan origination fees will likely be three or four times more expensive. Because private lenders are taking on more risk, they charge more. Private lenders are willing to accept a lower loan-to-value (LTV) ratio (which is the total loan amount divided by the value of the property), so while conventional loans have a LTV ratio upwards of 75 or 80 percent, hard-money loans are more commonly down around 50-65 percent.

The people who choose hard-money loans typically have poor credit or no established credit, little or no verifiable income, or they are purchasing property that won’t qualify for conventional loans (like raw land or real estate that requires rehabilitation). Another reason people choose hard-money loans is because these loans can sometimes be quicker and easier to secure; conventional loans take time and if an opportunity or need with an immediate deadline arises, then there may not be time for a conventional loan to be processed.

Since the recession of 2008, private lending has become more difficult because legislators passed the Dodd Frank bill and others, putting tougher restrictions on all lending. One of the bill’s new requirements is that private lenders must hold a license called a mortgage-loan originator license in addition to a real estate license. The new restrictions caused many private lenders to stop lending, and those of us who stayed in the business to stop offering some of the more troublesome loans, like those secured by owner-occupied properties and consumer loans.

Private lending through a broker can be a worthwhile investment if you’re willing to take on a little more risk for the opportunity to earn more than banks or bonds will pay. State laws require that loans made with an annual percentage rate that exceeds 10 percent to be arranged by a broker. The disclosures the broker must make are significant for borrower and lender, so if you head down this path, be prepared to review a lot of documents.

If a borrower defaults, the lender can foreclose and ultimately claim ownership of the real estate securing the loan or in some cases be paid off. It’s not a quick or easy process (for non-owner occupied properties it’s about four months), but it is not terribly expensive, so it makes the process less stressful.

Bottom line: for some borrowers acquiring a hard-money loan is a method to obtain needed cash, and for some investors it’s an avenue to higher returns. (By the way, investors can use retirement account funds for this type of investing.) As long as both sides negotiate in good faith, both sides are likely to get what they wish from the transaction.

If you have questions about real estate development or any other real estate or property management issues, please contact me at rselzer@selzerrealty.com or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com.

Dick Selzer is a real estate broker who has been in the business for more than 40 years.