InfoBarrel > Business & Money > Finance > Credit & Loans

Alternative Lending Offers A Market Based Solution To Shortcomings Of Traditional Lending

0 Comments | Rating: 0 | |

Sometimes a corporate borrower needs liquidity, but doesn't qualify for traditional property loans or mortgages (especially non-conforming loans). These secured loans based on real estate collateral are often referred to as "hard money loans." The “hard money lender” is the institution that specializes in this type of loan. They quickly evaluate the borrower and the property, and are prepared to write checks quickly to satisfy the liquidity needs of the borrower.

Hard money lenders charge higher interest rates than traditional property backed lenders, as there is a much higher risk of default, and often the hard money loans are the last secured lenders to get their money back in bankruptcy filings. Typically, such loans are capped at around two thirds of the most recent appraisal value for the property in repaired condition, often quoted as an ARV (after-repair value). The loan contracts are written for short durations (sometimes called called bridge loans) while the property owner works out a more permanent financing situation or resolves the financial distress that prevents them from securing other financing. Thus, hard money lenders tend to have a higher proportion of their loans contested in court.

As a result of the increased risk profile of their clientele, the high interest rates provide sufficient protection against impairment of the property, liquidity for the lender, and court costs and loan value impairments. The necessary interest rate may be so high that usury laws come into effect, so many states and localities effectively ban hard money lenders from practicing.

Thus the lenders in the industry are highly local, highly segregated and small organizations due to local regulatory practices. There are few regulatory organizations that provide oversight to this obscure market, and few names in the industry are known beyond professional real estate financiers.

This has the unintended effect of encouraging loan sharks and unscrupulous lenders to pretend to be hard money lenders, where they can charge extreme interest rates and often abuse the legitimate loan process. The victims of these lenders tend to be desperately in need of quick cash, and unsophisticated consumers who may not have the time to research the lenders or the technical understanding to know that they’ve signed their property as collateral to a 30% loan, perhaps with a quoted ARV lower than market, no prepayment allowed, or even worse lending terms.

Rates from legitimate hard lenders still tend to be rather high, but a Prime plus fifteen rate is more common, generally with as much as five points on a hard money loan. The rate a specific hard money lender will quote depends on the credit rating of the individual or company, the local real estate market for the type of property secured, local usury and bankruptcy laws, as well as the general availability of credit in the marketplace. Many commercial real estate developers know multiple local hard money lenders, and can shop around to get access to lower rates, higher ARVs, and less onerous terms, but individuals hoping to refurbish and flip a real estate investment should carefully research any individual firm they consider financing with.