Bankers’ Hours column: High interest hard money loan might make sense
December 30, 2018
These folks don't mince words.
The ladies and gentlemen who make private loans call their deals "hard money." They could use a more borrower-friendly term, such as, well, "private financing." But they get right to the point, maybe because they don't want to waste everybody's time by sugar-coating a 12 percent interest rate.
As Sally said to Tom in "Godfather 1," "Nothing personal, just business." If paying a premium for a loan makes sense, Mr. or Ms. Borrower, let's have a sit-down and see if it works for both parties.
Hard money is used, mostly, to describe non-institutional (bank) real estate financing. It's almost exclusively for non-consumer related loans, which are mortgages collateralized by the borrower's primary home. These home loans are covered by a virtual book of consumer protection laws that, first, don't permit the yields this financing seeks and, second, the penalties for making a mistake in loan disclosure or execution are very punitive, both as to monetary cost or, in some instances, could lead to actual criminal prosecution. Most HM lenders won't touch a primary home loan.
But the high rate option is available for just about everything else, including single family rental units. It can be a particularly effective toll when a developer, or commercial property owner, needs to get a concept off the ground, prove its merit, and then move on to bank financing.
Like most areas of lending, the business has changed since the Financial Crisis of 2008. Mainly, the HM executives, as well as those lenders who act in their own behalf — that is, lend their own capital — have tightened their ship considerably. They act more like banks.
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Back in the day, in the last years of the last century and the early years of this one, the lenders often would make a loan on just about any property if they felt that the loan to value ratio was low enough. The country was riding a sustained upswing in property values, and by 2003, the upswing looked like it had morphed into a 45 degree acceleration, straight up.
What could go wrong with a 50 percent LTV in this circumstance? So what if the borrower can't service the debt? We'll put the property in foreclosure, but we'll never own it, because somebody will come along and buy it before the foreclosure sale, or outbid us on the courthouse steps.
But, as we all learned, when a big bubble bursts, virtually overnight, 50 percent becomes 90, 100 or 110 percent.
Now, all hard money lenders do what the wise ones did at the turn of the century. They might make a bet, but they don't depend on cashing in if the payout depends on foreclosure. They look for a viable exit strategy on the part of the borrower, and, yes, they act like a banker: They make certain that the borrower can likely service the debt while it's on the books.
Most hard money borrowers figure that the cost/benefit ratio is very much in their favor: a 12 percent rate and two points at closing is a bearable business expense given the profit potential. And a lot of HM lenders won't do a deal unless that factor is in the borrower's favor. Once I sent a new construction loan to a private lender on a spec residence that looked like a pretty good deal. The principal of the HM company took the file home in the evening and responded the next morning: "This borrower won't make enough out of the deal to justify our cost," he said. Granted, the cost with this particular capital source at the time, which was a few years ago, was around 15 percent, three points, and a hefty annual maintenance fee.
Which is another thing about HM lenders. They're fast decision makers. One lender, when I complimented him on his fast, less-than-24-hour decision (which was a negative one for the client, by the way), said, "We're in the decision making business."
But a fast "no" can often save a borrower real money. The best banks know this, and do their best to emulate their HM brethren. And it's important in another respect: Nobody wants to pay 12 if they can get five and a half. So the HM lender generally comes at the end of the string in the search for a loan.
In some ways, hard money lenders are more particular regarding the collateral than many banks. The majority eschew lot loans, and very few will touch raw land. Improved properties are almost always more marketable is the reason, of course.
As one would expect, private lenders are the only capital source for marijuana-related properties. They do this as meticulously as a bank would, if banks could currently make these loans.
Some practical advice for a borrower looking for a loan on any kind of commercially related property might be to go to your bank, which should be able to tell you if your deal is bankable. If not, do some simple math with the potential current hard money rate, which is pretty easy to determine, and currently ranges from 10-12 percent. Determine if your ultimate financial benefit makes sense with the cost of the money.
It'll be expensive, but you can get it quickly.
If paying more for the money makes you more money, it might be worth it.
Pat Dalrymple is a western Colorado native and has spent more than 50 years in mortgage lending and banking in the Roaring Fork Valley. He'll be happy to answer your questions or hear your comments. His e-mail is firstname.lastname@example.org.