Hard-Money Lenders

These Are Good Times for Hard-Money Lenders
by Jack M. Guttentag
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Good (202 Ratings)
Posted on Monday, November 10, 2008, 12:00AM
Like all disasters, the financial crisis has its share of beneficiaries who profit from it. The hard-money lenders, who lend strictly on the basis of collateral, have profited from the financial meltdown. These non-institutional lenders require a lot less paperwork than institutions because they don't worry about whether or not borrowers can afford the payments, or whether or not they are creditworthy. They don't bother with income, employment, or credit reports.
If borrowers can't pay, the hard-money lenders get their money back through foreclosure. They typically require 30 percent to 35 percent down to make sure that there is enough equity available to cover foreclosure expenses. Interest rates are much higher than those charged by institutions, and terms are short.
The earliest mortgage lenders of the 19th century were focused entirely on the collateral. Through necessity, they were hard-money lenders. There was no way to document anyone's income in those days, and credit reporting had not yet emerged.
Lending Over the Decades
Over the decades, loan underwriting increasingly came to emphasize the capacity of borrowers to repay their mortgage as indicated mainly by their incomes relative to their expenses, as well as their willingness to repay as indicated by their credit record. Rules regarding how both the capacity and willingness to pay had to be documented came to fill many pages of underwriting manuals. As collateral became less important, down payment requirements declined and, in many cases, disappeared entirely.
Hard-money lending today is thus a throwback to the era before the capacity and willingness of mortgage borrowers to repay became important parts of loan underwriting.
The financial crisis has been good for hard-money lenders because it has made loans with less than complete documentation of income and assets extremely difficult to obtain from institutional lenders. Here is a recent example from a letter I received:
"I bought my permanent residence for $300,000 in 2005, paid all cash, but now I need $80,000 to make repairs and can't find a loan. I live off the income from other properties that I own, but I show very little income on my tax returns because most of it is shielded by depreciation and interest costs. None of the lenders I have approached will give me a loan."
Before the crisis, this borrower would have had no difficulty finding a "stated-income loan", meaning one where the borrower stated his income but was not required to document it. Indeed, the stated-income loan was designed to meet the needs of exactly this type of borrower. The interest rate would have been only .25 percent to .5 percent higher than the rate on a fully documented loan.
But as underwriting rules loosened during the go-go years of 2000 to 2006, stated-income loans came to be called liars' loans because they were so often used to qualify borrowers for mortgages they could not afford. The presumption was that rising home prices would allow them to refinance to a lower rate later on or, if necessary, to sell the house at a profit. Instead of reflecting real income that could not be documented, stated income often reflected income that did not exist.
As the financial crisis emerged and foreclosures mounted, hostility against liars' loans grew. The notion took hold among regulators, legislators, and even many loan providers that every mortgage borrower should be required to document their ability to repay the mortgage. While, to my knowledge, none of the attempts to enact this rule into law were successful, the market's response to the crisis has essentially done that job. Stated-income loans have become difficult or impossible to obtain from institutional lenders.
So I had no choice but to advise the letter-writer above to find a hard-money lender. The rate premium, relative to the cost of a documented loan from an institutional lender, will be much higher than .25 percent to .5 percent. As partial consolation, there are a lot of these lenders out there.
Hard-money loans should be relatively easy to shop because their rates don't bounce around from day to day, as they do in the institutional market. I don't have any experience with this market, however, and readers who have taken loans from hard-money lenders are invited to let me know how they did.
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81 Comments
Showing comments 1-5 of 81Next >> Sort: first to last
Yahoo! Finance User - Thursday, November 13, 2008, 1:56AM ET Report Abuse
Overall: 1/5
Hard money lenders are not only going out of business faster than traditional banks, but the 35% equity that was their cushion is gone in most places where these loans are necessary. MoneySpot.com lists hard money lenders in California and the numbers keep dropping. I like the service, but it is getting harder and harder to find hard money lenders that want to lend, especially with an extended time frame--six months or a year is just not long enough in this market. You need to talk with hard money lenders and you will see the problems are there as bad as anywhere. These are NOT good times for hard-money lenders.
Yahoo! Finance User - Thursday, November 13, 2008, 12:07AM ET Report Abuse
Overall: 2/5
Prof. Guttentag is one of the most respected experts on the Mortgage industry but his description of the hard money industry is somewhat oversimplified. As a commercial hard money lender and broker in California I can tell you it is true that collateral value is the key to hard money underwriting, but a very close second is the exit strategy. IOW, a good hard money lender has no interest in foreclosing. Of course we will if it comes to that (and as we see today so will commercial banks) but hard money isn't stupid money. The value provided to the borrower is speed, flexibility in terms, and frequently the opportunity to save a property or obtain a great deal that would otherwise not be possible. Yes, hard money can be expensive compared to a bank or conduit lender, but it's way cheaper than equity. This is not (generally speaking) a loan-to-own industry. At my company, Shepherd Capital Partners, if we don't see a reasonable strategy to repay the loan we will not make it. It's easy to vilify the investor charging 12% or more for a loan, but what we do is far more ethical than the multitudes of traditional lenders pushing billions of dollars of "pick-a-payment" loans on borrowers who didn't understand what they were getting into and had no hope of ever servicing the loan.
B. Graham - Thursday, November 13, 2008, 12:01AM ET Report Abuse
Overall: 3/5
I see hard money deals fly across my desk at 15% interest, 12 mo term, 6 mo debt service reserve, construction improvement reserve, and 6 pts up front...one good thing about hard money lenders is that they can close very quick. I actually workout commercial loans for a number of institutional owners and will typically take a DIL to preserve the debt and restructure the debt through a short sale, the same way a hard money lender would provide financing. Sure, I may have to write-down the loan but my net present value is much greater by preserving the debt and improving the collateral and getting a healthy return rather than selling it for all cash where by killing the leveraged return for the buyer…I’ve also seen deals where buyers are willing to give an equity kicker on the residual.
Yahoo! Finance User - Wednesday, November 12, 2008, 11:53PM ET Report Abuse
Overall: 1/5
bunch of nonsense, most of the hard money came from people or business that had access to LC that they paid prime, and wanted to make some money.... all of that dried out, plus no one wants and knows how to appraise value in equity, as there is no light in the end of the tunnel yet
Yahoo! Finance User - Wednesday, November 12, 2008, 10:34PM ET Report Abuse
Overall: 1/5
no one knows true values in this market. there is no easy way to lend!
Showing comments 1-5 of 81Next >>
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