Hard Money Loans Q & A
by S. Clay Sparkman
What is private money used for?
Private money is generally used as a bridge: a way to get from point A to point B. It is a short- to medium- term solution (1-6 years), and there is nearly always an exit strategy going in. It is used for all types of real estate secured financing: commercial retail, restaurants, hotels/motels, marinas, elder care facilities, industrial, agricultural, raw land, land development, construction, rehab, multi-family, single family homes, manufactured homes, and floating homes.
What are the interest rates?
Private money rates generally range from 10 to 15%. The rate is determined by looking at a combination of factors: (a) LTV ratio, (b) strength of borrower, (c) condition/desirability of property, (d) actual cash-in or real equity contributed by borrower.
What fees are involved?
Lender fees are also more expensive than those involved with conventional mortgages. Whereas a typical conventional lender may charge a 1-point origination fee, typical private money origination fees are between 3 to 6 points.
Why would anyone pay those kinds of rates and fees for a loan?
Essentially, commercial real estate investors use private money for those situations in which a conventional lender simply will not lend on a property. The great majority of private money loans allow an investor to make a profit he would not have been able to make otherwise.
There are several typical reasons a conventional lender may not be able to lend on a property:
- Poor or incomplete property condition
- Unconventional property type (for instance, banks don't like lending on raw land and lots, but private money lenders are more inclined to do so)
- Insufficient cash leverage
- A seller carry-back is involved in the transaction
- Borrower requires fast closing
- Borrower credit score too low
What is the justification for such rates and fees?
There is a reason conventional lenders won't lend on the projects that private money lenders fund: these projects are simply too risky for them. Essentially, private money lenders protect themselves from this higher risk in two ways: 1) They charge higher up-front fees and interest rates to offset the potential cost of dealing with the risk factors, and 2) They limit the loan-to-value ratio to 65-70% (generally), so that if the borrower defaults on the loan, they can still recover their investment after going through the legal expenses of foreclosure.
How fast can private money loans close?
Generally a private money lender will be able to fund in 2 or 3 weeks. In some circumstances a lender may be able to close within a matter of days.
Is an appraisal required?
Although private money lenders' documentation requirements are always less cumbersome than those of conventional lenders, what materials are requested from the borrower for evaluation of a scenario varies widely. Some require an appraisal, some are able to work with a comparable sales analysis only.
Why do they call it "hard money"?
It is difficult to find an answer to this question. Some people say that it's because the money is used for "hard to do" loans. Others say it is because the loans are "hard to get" or "hard to pay." A more likely explanation, however, is that it is called hard money because traditionally it has been "real money" in the sense that it is not borrowed. Institutions loan borrowed money, and in this sense they loan "soft money." However, things have changed a bit over the years, and these days a good deal of hard money is in fact borrowed.