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hard money and private money

March 28th, 2011 5:35 PM by Chuck Green

This past weekend I was thinking a great deal about private money - also known as hard money. I am always reluctant to put a client into a hard money loan; despite that, at BACF Inc., hard money lending is growing faster than any other segment of our business. Of course, this is merely a reflection of the banking industry being unwilling to lend. Now, "unwilling to lend" is a harsh term of course and all the banks can dredge up statistics to show that they are in fact lending. The problem is that really that they are lending under such strict guidelines that a large segment of market demand - both for residential and commercial lending - has no where to go. There are simply no programs available for those individuals with tarnished credit, insufficient or non-verifiable income, past bankruptcy or foreclosure, or issues related to asset verification, income or job history, or credit history. On the commercial side, programs and guidelines have also tightened, property values have declined, and in some cases vacancy has risen, or rent incomes have declined; as a result of this there has been an enormous vacuum created and many commercial properties are searching for a source for any possible source for refinance funding. For example, debt service coverage ratios, which in the pre-meltdown world of lending were accepted in the range of 1.1 - 1.3; are now in the post-meltdown world expected to be 1.25 as a general minimum and in some cases we see guidelines requiring DSCR of 1.4 to 1.45, at a minimum. Likewise most of the big banks now expect an LTV of 65% at the most (we know of a couple banks that will still allow up to 80%). As a bank, if you require a DSCR of 1.35 and will lend at 65% of market value, then you know very well that you are excluding as much as 75% of the commercial paper from refinance. You are "cherry picking" loans of unquestioned value. You are protecting your shareholders, and yes you are protecting your own job as a bank officer but I believe it is a stretch to claim that this is serving any great need in your community. Because the need is there.

Anyway, all of this commercial and residential lending that should be going to banks is falling into the hands of private lenders and hard money loans. BACF Inc does a number of hard money loans every month; primarily in San Mateo and San Francisco and Santa Clara counties, but also a growing number of these loans in Marin, Alameda and Contra Costa County as well. I define a hard money loan as any loan that is at least four percentage points higher in either rate or fee, than what the same loan would be from a bank. They are expensive, but what is the alternative if you need a loan?

The biggest controversy right now with hard money loans is related to their use and appropriateness for owner occupied residence loans. Residential owner occupied loans are afforded much greater protection for the consumer. Both RESPA and HOEPA regulations make it very difficult for consumers to refinance their owner occupied properties using hard money; likewise an unwary lender has great liability in creating a hard money loan for an owner occupied residence without a great deal of care, caution, and extra paperwork of course.

As a consumer, it is important to be cautious when applying for a hard money loan. I have certainly heard of many hard money loans in my day that were - in my opinion - more expensive than they should of been. In most cases the lender or investor should be charging no more than four points, and a broker such as BACF should be charging one to two points, at the most. Most of our transactions involve less than six points, but typically more than four points. in most cases, there is no need to pay more than six points. Recall a point is 1% of the loan amount.

Rates for hard money loans are typically more than 10%; in some cases however for very strong files we see rates in the mid-nines. A typical rate will range between 10.25% and 11.50%. To me, the points are more important than the rate since the private loan is hopefully a bridge loan of sorts to move you from a difficult situation into (we hope) a situation where we can assist with an eventual refinance into a more conventional loan - residential or commercial - with rates at a more market appropriate level.

Watch for prepayment penalties with hard money loans also. We see a wide variation of lender expectations for prepayment penalties. Obviously, if you have a three year loan term and a three year prepayment penalty then there is something wrong. Avoid defeasance fees; avoid yield maintenance agreements, and try to avoid any prepayment penalty that exceeds 2% of the loan balance as a penalty. The lenders we work with will in most cases either waive a prepayment penalty completely or add a simple interest guarantee for six to twelve months.

Most private mortgage lenders will not require much in the way of income documentation, and they will not care much about your credit. But private mortgage companies are all different and in my opinion finding the right private lender is the most critical part of the equation. We have had some clients who just barely miss qualifying for a bank loan...there are special private lenders for these situations. Often, the companies (private lenders) with the best rates and fees will ask you to provide full income and asset verification, and expect you to have at least decent credit. But if you qualify you could find yourself with a rate in the nines and maybe three points paid.

For example, we had a client recently who was an "A Paper" (bank) candidate in every way, with the exception that he was buying a bank owned property, so he needed a quick process, and in addition he was using an unrelated second property of his as collateral. Banks are reluctant to cross collateralize, and in our current market, they do not move quickly....for this reason, we needed to involve one of our private money lenders. For now, his loan is approved and ready to go while he continues to search for the right property. In the end, he will acquire a property that is worth about $425,000 for a price of about $230,000 to $240,000. In his mind, the extra cost of the loan is incidental compared to the savings he will make by buying the property at such a discount.

A common misconception about hard money loans is that they will allow a small down payment. This is not the case; hard money is relaxed about most issues but equity and down payment are not on that list. Hard money lenders can work with an LTV of up to 65%; however in some cases I have seen recently private lenders have offered loans at LTV's as low as 45% of current market value. If your situation is complicated in any way, you should expect an LTV of about 50 or 55%.


Posted in:General
Posted by Chuck Green on March 28th, 2011 5:35 PM