Hard Money Loan
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A hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by real property. Hard money loans are typically issued by private investors or companies. Interest rates are typically higher than conventional commercial or residential property loans because of the higher risk and shorter duration of the loan. Most hard money loans are used for projects lasting from a few months to a few years. Hard money is similar to a bridge loan, which usually has similar criteria for lending as well as cost to the borrowers. The primary difference is that a bridge loan often refers to a commercial property or investment property that may be in transition and does not yet qualify for traditional financing, whereas hard money often refers to not only an asset-based loan with a high interest rate, but possibly a distressed financial situation, such as arrears on the existing mortgage, or where bankruptcy and foreclosure proceedings are occurring.
The qualifying criteria for a hard money loan varies widely by lender and loan purpose. Credit scores, income and other conventional lending criteria may be analyzed. However, most hard money lenders primarily qualify a loan amount based on the value of the real estate being collateralized. Typically, the biggest loan one can expect would be between 65% and 75% of the property value. That is, if the property is worth $100,000, the lender would advance $65,000 – $70,000 against it. This low LTV (loan to value) provides added security for the lender, in case the borrower does not pay and they have to foreclose on the property.
A hard money loan is a species of real estate loan collateralized against the quick-sale value of the property for which the loan is made. Most lenders fund in the first lien position, meaning that in the event of a default, they are the first creditor to receive remuneration. 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 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 between 60 and 70% of the market value of the property. For the purpose of determining an LTV, the word “value” is defined as “today’s purchase price.” This is the amount a lender could reasonably expect to realize from the sale of the property in the event that the loan defaults and the property must be sold in a one- to four-month time frame. This value differs from a market value appraisal, which assumes an arms-length transaction in which neither buyer nor seller is acting under duress.
Below is an example of how a commercial real estate purchase might be structured by a hard money lender:
65% Hard money (Conforming loan)
20% Borrower equity (cash or additional collateralized real estate)
15% Seller carryback loan or other subordinated (mezzanine) loan