If borrowers give you grief about turning down their application, it’s probably because they have these misperceptions about hard money lending.
Hard money lenders tend to see just about every type of loan request on the planet. The reality is that many of these loans have no prayer of ever getting funded.
Most people simply don’t understand how hard money loans work or what a hard money lender will fund and will not fund. The following are the most common examples of loans that get an immediate decline.
- Loans Against Soft Assets
Hard money lenders make loans against hard assets. The word “hard” in the term “hard money” implies that a lender makes a loan using a hard asset as collateral.
By definition, a hard asset is a tangible, physical asset such as real estate. In contrast, a soft asset is an intangible asset such as a stock or a patent. A hard money lender just won’t fund a loan against a soft asset.
Hard money lenders don’t do private equity, startup financing or seed capital. A request for private equity or seed capital is the most common loan request a hard money lender declines. Why? Because the collateral is stock, which is a non-physical asset. Hard money lenders issue debt, not equity.
- Loans with No Exit Strategy
A loan with no viable exit strategy is another good candidate for an immediate decline. A hard money loan is short-term in nature and comes with a higher interest rate, so the exit strategy is very important to the lender. How will you get paid back if a borrower has no real plan for paying you back?
When a hard money lender asks a borrower, “What’s your plan for paying this loan back?” and the borrower has no viable exit strategy, the lender will certainly decline the loan.
Why won’t a hard money lender give a loan to a borrower with no exit strategy? Would you make a loan to someone who had no viable way to pay you back?
- 100% LTV Loans
Although some government- backed loans require no money down, most lenders won’t lend at 100% loan to value. There is a well circulated myth out there that hard money lenders lend at 100% loan to value. The truth is, hard money lenders generally value properties more conservatively than traditional lenders. And often, hard money lenders require larger down payments as compared with the down payment requirements of traditional lenders.
This generalization certainly excludes lenders on fix and flips, because fix-and-flip lenders lend on improved value, or future value. But even fix-and-flip lenders only lend at a certain percentage of the improved value, not 100%.
Why won’t most hard money lenders make 100% loan to value loans? These loans are just too risky for a hard money lender who makes lending decisions based primarily on the asset itself. Unlike a bank, which takes tax returns from a borrower to prove an ability to repay, a hard money lender can only rely on the asset to repay the loan in the event of a borrower default.
No hard money lender will lend on just a dream alone. Unfortunately, this is all that many borrowers have to bring to the table—nothing more than a dream. Although a borrower’s dream may be inspiring, a dream on its own won’t get a borrower a loan.
Hard money lenders often look at three primary criteria for loan approval, sometimes called “the three Cs”: collateral, cash and character.
Although “collateral” seems obvious, “cash” refers to how much cash a borrower can bring into a purchase of a property, or how much cash a borrower already has into a property owned. Cash can also refer to how much cash a borrower has on hand, or the borrower’s liquidity.
The third, “character,” generally refers to the borrower’s track record or a borrower’s specific experience with the particular property type being used as collateral for the loan. For example, a borrower may not have much cash, but could have good collateral and good character in the form of previous experience with the lender or experience with that specific property type. In this example, the borrower’s good collateral and character could offset the lack of cash and still gain a loan approval from a hard money lender.
Or, a borrower may have good collateral but no cash or experience. Although less common, if the hard money lender is an asset-based lender, the good collateral could result in a loan approval despite the borrower’s lack of cash and experience.
What if a borrower comes to a hard money lender for a loan and doesn’t possess any of these three criteria? In other words, what if a borrower has lousy collateral, zero cash and no prior experience? This is what a hard money lender calls a “dream,” in contrast to a real loan opportunity.
Why won’t a hard money lender give a loan on just a dream? Would you lend to a borrower with lousy collateral, no cash and no character?
- Consumer Loans
A consumer loan generally implies consumer purpose or “household use.” A residential property that is occupied by the borrower falls under the category of consumer. New consumer mortgage lending laws are cumbersome to comply with due to complex disclosures and other requirements. For this reason, even the big banks have turned their focus away from mortgages and have been funding other types of consumer debt instead.
With tighter lending laws in place post-Great Recession, borrowers who can’t qualify are seeking other options for home loans. These borrowers quickly discover that there are very few options available to them from hard money lenders. This is because most hard money lenders simply will not make consumer loans because the regulatory compliance and licensing requirements of consumer loans is just too overwhelming for private lenders who have limited resources.
There are a lot of myths and misperceptions about hard money lenders that don’t reflect reality.
All lenders have been forced to adapt to the drastic changes in the lending environment in the past decade. The hard money lenders that survived the last real estate crisis have certainly evolved and changed their business models.
Despite the changes in private lending over the past decade, old perceptions tend to die hard. And until the perceptions about hard money start to change, hard money lenders will continue to receive loan requests that have no chance of getting funded.
About the Author
Corey Dutton is the founder of Private Money Utah, a real estate lender that focuses on the Western U.S. Corey lends primarily to real estate investors to help them create successful real estate investments. She has funded more than $150 million in real estate loans since 2008. Corey is a licensed principal lending manager. She obtained her MBA in 2005 from the Thunderbird School of Global Management.