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The Structure of Hard Money Loans

A hard money loan is a type of real estate loan collateralized against a “quick-sale value” of the property that is being financed. Most hard money lenders require the first lien position, meaning that in the event of a default, they are the first creditor to receive payment after the sale. Occasionally, a lender will subordinate to another first lien position loan; this loan is known as a mezzanine loan, a second lien or a junior lien.

Hard money lenders structure these hard money loans based on a percentage of the quick-sale value of the subject property. This is called the loan-to-value or LTV ratio and typically hovers around 60% of the current market value of the property. For the purpose of determining an LTV, the word "value" is defined as "today's purchase price." This “value” is the amount a lender could reasonably expect to get from the sale of the property in the event that the buyer defaults and the property must be sold in a quick sale of 1 to 4 months. This value differs from a full market value appraisal, which assumes a longer sales cycle of up to a year in which neither buyer nor seller is acting under duress.

Below is an example of how a commercial real estate purchase could be structured for a hard money loan:

60% Hard money (Conforming loan)
30% Borrower equity (cash or additional collateralized real estate)
10% Seller carry back loan or other subordinated (mezzanine) loan

The History of Hard Money Loans

Hard Money is a term that is used exclusively in the United States and Canada where these types of loans are most common. In commercial real estate, hard money developed as an alternative "last resort" for property owners seeking capital against the value of their holdings. The industry began in the late 1950s when the credit industry in the U.S. underwent drastic changes.
The hard money industry suffered severe setbacks during the real estate crashes of the early 1980s and early 1990s due to lenders overestimating and funding properties at well over market value. Since that time, lower LTV rates have been the standard for hard money lenders seeking to protect themselves against cyclical market volatility. Today, high interest rates are the mark of hard money loans as a way to compensate lenders for the considerable risk that they still do undertake.

Cross Collateralizing a Hard Money Loans

In some cases, the low LTV ratios do not facilitate a loan sufficient to pay off the existing mortgage lender, in order for the hard money lender to be in first lien position. Because a security interest in the property is the basis of making a hard money loan, the lender usually always requires first lien position of the property. As an alternative to a potential shortage of equity beneath the minimum lender LTV guidelines, many hard money lender programs will consider a "Cross Lien" on another of the borrowers real estate holdings. The cross collateralization of more than one property on a hard money loan transaction, is also referred to as a "blanket mortgage". Not all homeowners have additional property to cross collateralize. Cross collateralizing or blanket loans are more frequently used with investors on Commercial Hard Money Loan programs where the investment group may hold many properties.

Commercial Hard Money Loans

Commercial hard money is another form of hard money loan and is similar to traditional hard money, but is usually more expensive since the inherent risk is always higher on investment property or non-owner occupied properties. Commercial Hard Money Loans may not be subject to the same consumer loan safeguards as a residential mortgage in the state the mortgage is issued. Commercial hard money loans are often short term and therefore also referred to as bridge loans or bridge financing.

The Commercial Hard Money Lender and Bridge Lending

Commercial hard money lender and bridge lender programs are similar to traditional hard money in terms of loan to value requirements and interest rates. A commercial hard money or bridge lender will usually be a strong financial institution that has large deposit reserves and the ability to make a discretionary decision on a non-conforming loan. These borrowers are usually not conforming to the standard Fannie Mae, Freddie Mac or other residential conforming credit guidelines. Since it is a commercial property, they usually do not conform to a standard commercial loan guideline either. The property and or borrowers may be in financial distress, or a commercial property may simply not be complete during construction, have its building permits in place, or simply be in good or marketable conditions for any number of reasons.

Some private investment groups or bridge capital groups will require joint venture or sale-lease back requirements to the riskiest transactions that have a high likelihood of default. Private Investment groups may temporarily offer bridge or hard money, allowing the property owner to buy back the property within only a certain time period. If the property is not bought back by purchase or sold within the time period the commercial hard money lender may keep the property at the agreed to price.

Traditional commercial hard money loan programs are very high risk and have a higher than average default rate. If the property owner defaults on the commercial hard money loan, they may lose the property to foreclosure. If they have exhausted bankruptcy previously, they may not be able to gain assistance through bankruptcy protection. The property owner may have to sell the property in order to satisfy the lien from the commercial hard money lender, and to protect the remaining equity on the property.

The Commercial Hard Money Lending Industry

Thanks to freedom from regulation, the commercial lending industry operates with particular speed and responsiveness, making it an attractive option for those seeking quick funding. However, this has also created a highly predatory lending environment where many companies refer loans to one another (brokering), increasing the price and loan points with each referral.

There is also great concern about the practices of some lending companies in the industry who require upfront payments to investigate loans and refuse to lend on virtually all properties while keeping this fee. Borrowers are advised not to work with hard money lenders who require exorbitant upfront fees prior to funding in order to reduce this risk. If you feel you have been the victim of unfair practices, contact your state's attorney general office or the office of the state in which the lender operates.

The Legal and Regulatory Issues of Hard Money Loans

From inception, the hard money industry has always been formally unregulated by state or federal laws, although some restrictions on interest rates (usury laws) by state governments restrict the rates of hard money such that operations in several states, including Tennessee and Arkansas are not workable for lending firms.

The Points on Hard Money Loans

Points on a hard money loan are traditionally 1 to 3 more than a traditional loan, which would amount to 3 to 6 points on the average hard loan. It is very common for a commercial hard money loan to be upwards of four points and as high as 10 points. The reason a borrower would pay that rate is to avoid imminent foreclosure or a "quick sale" of the property. That could amount to as much as a 30% or more discount as is common on short sales. By taking a short term bridge or hard money loan, the borrower often saves equity and extends his time to get his affairs in order to better manage the property.

Interest Rates on Hard Money Loans

Hard Money Mortgage loans are generally more expensive than traditional sub-prime mortgages. However all mortgage loans are not necessarily considered to be a high cost mortgage. Generally a hard money loan carries additional risk that a borrower is aware of. Private investors are generally only willing to create hard money loans in return for a very high interest rate (often about 11.5% plus five points for residential home purchases). Rather than selling the property a borrower will opt to keep the loan and if a lender is willing to assume some of the risk by offering a hard money loan. The rate is not dependent on the Bank Rate. It is instead more dependent on the real estate market and availability of hard money credit. As of 2008 and for the past decade hard money has ranged from the mid 12%–21% range. When a borrower defaults they may be charged a higher "Default Rate". That rate can be as high as allowed by law, which may go up to or around 25%–29%. Some private lenders will collect a prepayment penalty and some will not.