Hard money lending differs from traditional bank financing in a number of ways. For starters, hard money lenders are private investors or fund managers rather than commercial banks. They do business differently. As a result, they expect three key things from borrowers in order to approve and fund loans.
Those three things are:
- a hard asset
- a workable exit strategy
- a significant down payment.
A borrower who brings all three things to the table can pretty much count on approval. And with approval comes fast funding. Without all three things though, it is a crapshoot. Hard money lenders are more reluctant when they don’t see all three.
Hard Assets Act as Collateral
Hard assets are the foundation of hard money lending. That is where the practice gets its name from. At Actium Partners, based in Salt Lake City, UT, the hard assets they are most interested in are directly linked to the types of loans they make.
Most Actium loans go to real estate investors looking to add new properties to their portfolios. The properties themselves end up being the hard assets offered as collateral. The key thing to understand is that hard money lending is asset-based lending. Approval is only given if a borrower can offer a hard asset with a higher value than the loan amount. How much higher depends on lender standards.
Exit Strategies Equal Plans
Hard money lenders prefer to keep terms as short as possible. They are making high risk loans, so they want to get out in a timely manner. Thus the need for a sound exit strategy. Every hard money applicant must have a sound exit strategy to get approved.
In short, exit strategies equal plans. An exit strategy is a workable plan to repay a hard money loan on time and in full. A good example would be an investor looking for a hard money loan to close on a new property. Once closed and generating rental income, the investor can then go to a bank for a traditional loan. That loan pays off the hard money loan.
Down Payments Equal Skin in the Game
The hard money lender’s third expectation is a significant down payment. Down payments represent skin in the game, so to speak. And that is especially important to a hard money lender. It is so important that hard money lenders tend to have much lower LTVs compared to banks. Where a bank might offer a 75% LTV on a residential mortgage, the hard money lender down the street might max out its LTV at 50%.
If you are not familiar with LTV, it is an acronym that stands for loan-to-value ratio. Let’s say a hard money lender’s LTV is 50%. That lender would be willing to loan no more than $500,000 on a $1 million property.
Too Much Risk to Take
As previously mentioned, hard money loans tend to be high risk loans. There is too much risk for the lender to take the majority of it alone. So to protect themselves, lenders seek to spread out the risk as evenly as possible. That’s why they require hefty down payments. They want borrowers to have plenty of skin in the game.
Hard money lenders almost never ask for profit and loss statements or income verification. They rarely look at credit scores except for the purposes of determining interest rates. Hard money lenders also don’t demand reams of documents for underwriting purposes. If you have a hard asset with strong value, a solid and workable exit plan, and a significant down payment, your chances of approval are pretty good.