Defining Hard Money Loans

More and more I am getting questions about hard loans from borrowers and/or brokers who have never contemplated getting one or originating one for their clients. Some of the questions are related to underwriting and some to costs. Other questions are about ltv, property types, terms etc… Here I want to start addressing these questions and continue to provide insight on hard money or private lending. One point that I would recommend to keep in mind all private lenders have slightly different ways to underwrite and approve loans. This is good for borrowers as they can be turned down by one lender and approved by another one.

Let’s looks at some of the criteria that make a loan a hard money one. The primary criteria that all private / hard money lenders will agree on is that these loans are based on available equity in the property or loan to value (LTV). However, conventional real estate lenders both for residential and commercial properties have for primary criteria credit. In regard to the LTV, If the loan amount requested is too high in relation to the value of the property then the loan will be turned down. Hard money lenders today do not fund loans above a 70% LTV. In general depending on the area of the country and within states, it will be no more than 60% to 65% of the property value.

Going back to credit and Fico score. If a borrower has good credit it does not mean that his/her hard money loan will be approved. Good credit is only one of the criteria of the approval process. Also, this will not improve the rate that the borrower will get it just makes it more interesting. Today, as we have discussed in previous post, most hard money borrowers have good credit.

In today’s real estate market the property value is really crucial no matter if you try to finance a property through conventional means or through private-hard money sources. Again this both affect commercial and residential borrowers. Commercial valuations are in a way more accurate than residential ones as they are normally based on income. As with everything else there are always exceptions to the income valuation. Residential real estate is valued mostly based on its "perceived” exchange value. This is for most people the main sticking point nobody can really agree on what that means. I would recommend as a basis to think in term of 90 days. The value of a property can be based on its exchange price, if it had to be sold within 90 days. If the real estate industry was to ask appraisers to provide valuations based on this criterion, we all would have a much better idea of a property value.

More and more we are seeing values for residential properties based on the income they would generate if rented out. This is becoming a very important factor when approving financing for residential investment properties.

The Changing Nature of Hard Money Lending

Just this week a broker whom I work with regularly asked me why do we need some type of income documentation from her client? If we go back to what was Hard Money lending even a year ago this is a legitimate question. Remember when the only documentation that was needed to approve a loan was a breathing borrower, a 1003 and a property, today it’s a different world. Investors and lenders have learned that caution is the norm and that property can loose value. To illustrate theses changes here is an article from the AP, "When economy bottoms out, how will we know?" by Alan Zibel, Christopher Leonard and Tim Paradis, Business Writers

A different lending approach is being developed in the hard money world. Today you could define Hard /Private Money lending as flexible lending. Until mid August 2007, Hard Money lending was pretty much borrower’s bail out lending. When you could not get money from banks you were going to a hard money lender. Two primary reasons at that time either you were so desesparate as a borrower or the property was in such a bad shape that no conventional or subprime lenders could approve the financing. Here I am referring to residential lending as the commercial market was a little more reasonable.

The assumptions made by “most” private lenders at that time were that property values will continue to increase and that other sources of funds would be available to take out their loans. Since then the lending and financing world as radically changed. Values have collapsed and there is no capital available to do financing. Assumptions made are no more valid, thus private lending had to take a different approach.

Today private lending is more of flexible lending than bail out lending. Bailout loans are still being considered but at very low loan to values. Most of private lending today is done for investment properties and commercial properties that can not get bank loans. Banks do not approve loan for more than 4 residential properties. No more stated income loans, so self employed people are suffering, especially self employed investors. Hard money loans for borrower with low Fico (below 600) will be more complicated to get. In addition, more and more lender want to make sure that the borrower can make the mortgage payments.

In our next few posts we will continue to address these issues.

Appraisals and Values -- Getting it Right

As usual this week, most news relating to finance or the economy was not good or just depressing. However, some hope was provided to us via an interview in the California Report from Jerry Nickelsburg, an economist with UCLA’s Anderson School. Jerry mentioned that some real estate markets might have started to bottom out. These markets are the ones that have already seen a drop of up to 75% in value or more. Other markets are now seeing the effect of the lack of capital and might bottom out in 2009.

It is clear today that property values are linked to the economy in general and the availability of funds. If there is no money to borrow, then properties are not traded or traded only at lower prices. If people are losing their jobs, then they are not able to make their mortgage payments, thus starting to default, which increases the number of properties being foreclosed, etc. If people do not buy products in stores, then companies will start closing stores and laying off people, which worsens the downward spiral and directly affects the demand for commercial real estate. Bad economic times imply lower property values, especially in today’s environment. If you are wondering what the value of your real estate is, most likely it has gone down during the last year, even in popular resilient up-scale markets, like the good neighborhoods in San Francisco.

Knowing what we do about market conditions, it is surprising to still find appraisers, real estate owners and real estate professionals who believe that the market is doing better than it is. Every week, I come across numerous appraisal reports or property valuations, which for one reason or another show an increase in market values. How can we take these reports seriously? This week, an appraisal I received was so out of touch with reality that I took the pains to go over it in detail with the loan officer.

Today, we can only close a transaction if we make sure we understand the realistic current value of the property. This applies both to commercial and residential properties. Most of the loans that are funded now are funded because the loan officer and the borrower have a clear understanding of what the property value is. Serious and meaningful appraisal reports are very valuable, but difficult to come by. Since there are so many tools available today to estimate property values, there is no excuse for getting it wrong and for having inaccurate expectations. My recommendations are to do your homework thoroughly before you start any real estate financing process and to be conservative in estimating property values