4 ways to counter hard money’s sometimes disreputable image.
“Hard money” lending got its name back during the Great Depression after a large swath of the banking industry failed across the country. When property owners became desperate for cash, private individuals started lending money against real estate for interest rates that were higher than what the remaining banks charged.
It’s unknown exactly what the “hard” part of the expression refers to. Most people assume the term came about because these instruments are collateralized by hard assets like real estate or land, as distinct from soft intangible assets or future cash flows. Given its origin in the Depression, the reference could be because these loans were hard to get, or hard to pay back. Or, it could have been borne of the expression “cold hard cash,” meaning paper and coin currency.
What’s in a Name?
Regardless of the origin of the term, hard money lending tends to have a negative connotation in the marketplace. It’s associated with high interest rates, so critics tend to overlook its major benefits:
- Hard money lenders usually decide on a loan application in seven to 10 days, compared to 1-2 months for a traditional bank.
- Although due diligence is still required with private money, it involves much less red tape. The lender’s underwriter is not reviewing conditions to satisfy some third-party investor’s credit committee. In most cases, the lender is the investor. Private lenders also aren’t subject to the burdensome regulations created by the 2010 Dodd-Frank Act.
- For many construction projects, including fix-and-flip residential work, hard money loans are based on the property’s after-repair value (ARV); that is, what it’s expected to be worth once the project is complete. In contrast, a conventional lender must base it on the property’s appraised value at the time of origination.
In all these cases, the private lender absorbs significantly more risk than a bank would; therefore, the reward in the form of interest rates and origination fees must be higher. For borrowers, a high interest rate for a short period is often a minor expense compared to the money they stand to earn on the project.
Because the only collateral available to the hard money lender is the property that securitizes the loan, if a borrower defaults, then foreclosure is likely. This is where the reputation of hard money lending sours. When deals go south, it’s common for borrowers to fight foreclosure by raising usury claims against the lender.
All states have usury laws in place. These vary based on the types of lenders, borrowers and loan amounts. Many states like California have laws that cap interest rates generally. These caps are subject to certain exceptions based on what type of party made the loan or what kind of property was used as collateral. But, in many cases, borrowers in default raise legal challenges to argue that their lender should not be exempted.
Penalties for violating usury statutes include invalidation of a borrower’s interest obligation, recovery of double or triple the usurious interest paid, nullification of the loan or fines ranging up to six figures. Some states, such as Florida, even impose criminal penalties. Given that the state usury laws have teeth, it is not uncommon to see even spurious legal claims raised against hard money lenders.
Push Back Against a Reputation for Unscrupulous Activity
Like every other industry, private lending has seen its share of bad apples. Bad practices include bait-and-switch schemes in which a hard money lender promises the borrower a fixed-rate loan or specific interest rate but, without any explanation, switches them to a completely different loan.
In other cases, predatory lenders extend credit to borrowers without ensuring the borrower can service the debt, and then rapidly foreclose if the borrower misses a payment. The industry is mostly unregulated by federal or state authority; therefore, unscrupulous types have contributed to a bit of a rough reputation over the years.
Considering that the reputation of hard money lending may be tarnished in some quarters, what are private lenders to do? First and foremost, rely on very clear terminology for the products offered, like “bridge loans,” “asset-backed lending” or “short-term private debt.” In addition, there are four ways private lenders can go the extra mile and help restore the good name and reputation of the industry.
- Monitor and stay compliant with usury laws in the states in which you do business // While they may not always apply, a private-money lending professional should always stay aware of the usury statutes in their jurisdiction and stay on their right side. Failing to do so can encourage a lawsuit, given the extensive damages potentially available to a borrower—and lead to more bad publicity.
- Follow the TILA-RESPA Integrated Disclosure (TRID) rules for borrower documents // This is like inoculating your firm against claims of predatory lending for residential properties. These federal regulations changed the way lenders must review documentation, proving that the borrower can repay the loan. Because private lenders rely on the property’s equity as collateral, there can be a temptation to skip them. But if you are ever sued for a predatory lending process, demonstrating to the court that you followed TRID due diligence is compelling evidence to exonerate you.
- Stay on top of your online reputation and any new discussion threads // Create a process to monitor online activity in your market, including review sites like Yelp and Glassdoor, and network sites like LinkedIn, Facebook, Twitter and others. There are apps that do this work for you, but at minimum, set up a Google alert for your business name as well as your main competitors.Find complainers quickly and address their concerns fairly. Allow anyone to post feedback in a prominent page of your website, but ask each client who was happy with your loan to post a positive review. If someone posts a negative review, answer it publicly while demonstrating your commitment to “make it right.” Like all businesses, private lenders are responsible for creating the image of the firm they want customers to see, but don’t think this image begins and ends with your website. Thanks to social media, it is a much wider world out there.
- Add new blog content to your website, Facebook page, etc., on a regular basis // Blogging is an ideal way to share your company’s values with the public. Use blogging to explain the pluses and minuses of hard money loans, without being “too sales-y.” Demonstrate your industry expertise and begin to establish yourself as an influencer. Doing this well will get you lots of positive comments and help push any lingering old negative content off the first page of search engine results. Done well, it can also become a great vehicle for lead generation.
In “Hamlet,” Shakespeare famously writes, “Neither a borrower nor a lender be, for loan oft loses both itself and friend.” Naturally our industry disagrees. Private lending often provides the liquidity necessary to get exciting real estate projects off the ground and completed.
But over the years, the term “hard money lending” has taken some reputational hits.
If you follow the four suggestions above, you can contribute to a better understanding among the public of the important role of private lending in the U.S. market. ∞