Hard money lending is distinct and different from traditional lending. It shares some similarities, including the need for down payments and the practice of assessing points. But in terms of qualifications, underwriting, and funding, hard money stands out like a sore thumb. Consider the qualifications for approval.
Qualifying for a traditional loan depends almost entirely on proving your ability to repay. A bank will leave no stone unturned in its quest to discover even the most minute details about your financial history and current financial position. Underwriters will check your credit history and score; they will analyze your debt-to-income ratio; they will look into your retirement account, your investments, and so forth.
Hard money lending is entirely different. Approval is not based on the borrower’s ability to repay. Instead, it is based on the lender’s ability to recover the amount loaned. So lenders rely on three qualifications for approval:
1. Asset Value
Borrowers need to put up some sort of asset as collateral on a hard money loan. According to Salt Lake City’s Actium Partners, the vast majority of hard money loans fund property acquisitions. That makes this first principle easy to understand. In any such deal, the property being acquired is also the collateral on the loan.
Actium and its competitors want to see that the property’s value is high enough to cover the amount being borrowed. Borrowing just half the amount of a property’s value puts an investor in a strong position for approval. Asking to borrow upwards of 80% would put an investor at a greater risk of denial.
2. Down Payment and Equity
Hard money lenders utilize loan-to-value (LTV) ratios just like traditional banks. Let’s just arbitrarily consider a 50% LTV. The lender is willing to put up half the money; the borrower is expected to make up the other half.
That being the case, the second qualifying factor is a combination of the investor’s down payment and existing equity. A lender needs to be sure that the borrower actually has the financial resources to make a significant upfront investment. Without such resources, there is the risk that the investor either cannot truly afford the property or is in way over his head from an investment standpoint.
3. The Exit Strategy
Last but not least is the exit strategy. An exit strategy is an investor’s plan for paying off the loan on its maturity date. It is necessary because hard money loans are not structured the same way as traditional loans.
On a traditional loan, the borrower might make monthly installments over 10-15 years. But hard money loans are almost always structured as interest-only loans. Investors make monthly payments that cover only the interest. They must pay the principal on the loan’s maturity date.
In addition, hard money loan terms rarely exceed 36 months. Most hard money loans have terms from 6-12 months. Such a short term demands that the investor have a reasonable exit plan in place before his loan is approved.
A Word About Credit Scores and Histories
Hard money lenders tend to ignore credit scores and histories when making approval decisions. However, they may not ignore these two factors entirely. Some hard money lenders look at credit scores and histories to help guide decisions about interest rates and terms. Just like with traditional lending, lower credit scores and poorer histories tend to lead to higher interest rates and shorter terms.
Now you know what it takes to qualify for hard money. If you are a real estate investor with the right qualifications, hard money could represent a pretty good deal for you.
