What the Heck is Hard Money Lending?
Hard money lending is also sometimes called private lending, equity lending, or trust deed investing. (I use these terms interchangeably.) In its simplest form it is generally short-term, low-leverage loans with relatively high interest rates, made by private individuals, groups or institutions, backed by equity in hard assets. The most common asset being real estate, of course.
This is a brief overview but hard money lending is distinguished from conventional lending in the following way:
Conventional (bank) loans are what I call cash flow lending demenssyd.dk. The primary underwriting factors involve the borrower’s credit worthiness: willingness and ability to pay. The value of the actual property–the collateral–is an important but secondary consideration. For a residential borrower this means your credit history, and income level and stability is all important. In the commercial realm it means the property’s ability to cover the debt, as well as the sponsors financial condition. In short, the primary issue is the ability to make monthly loan payments.
Hard money loans flip this around. The single most important factor is the collateral itself: how much is the property realistically worth and how much equity cushion does it provide to protect the loan. The lender’s primary concern is, if the borrower defaults and he has to foreclose, can he quickly and easily dump the property and recover all of his principal and (hopefully) interest and fees.
The second critical factor in hard money underwriting is exit strategy, or how will the borrower repay the loan at the end of the term. Since most of these loans are short-term–1 to 5 years–there has to be a clear and plausible strategy for repayment.
Below these factors comes the borrower’s credit worthiness: ability and willingness to make monthly loan payments. Before the credit crisis this was barely a consideration at all. Since 2007 even hard money is looking a little more carefully at a borrower’s ability to service the debt.
Hard money lending (as we call it today) has been around for decades and until 20 years ago or so had a pretty seedy reputation as being not much different than loan sharking. While there are still unsavory characters in the lending business, the hard money profession has, overall, become quite professionalized. There are lenders that specialize in all types of assets and transaction types, and that provide outstanding and highly professional customer service. It is also a common misunderstanding that all hard money borrowers are financial hardship cases. This is simply not true. Private money provides a speed and flexibility that conventional, “check the box” lenders simply can not match. Many, if not most, hard money borrowers understand the strategic value that it provides in the appropriate situations.