Hard money is one possible method to obtain funding to acquire and add value to investment properties or land. Banks are another potential lending source. Yet banks often aren’t as willing to work with borrowers, especially new borrowers, as hard money lenders are. Asking “why not?” is a fair question. The different stakeholders each type of lender answers to is the cause for the different approaches each takes to lending. So why do private lenders finance loans that banks are afraid to approve?
Banks lend out the money they collect in deposits from the average consumer. A number of banks are also publicly traded companies. For both these reasons, banks are highly regulated. The high degree of regulation plus their obligation to protect depositors and shareholders makes them naturally risk-averse. They want to make safe loans to earn the interest paid. They don’t want to get involved in your real estate project beyond that.
On the other hand, hard money lenders use funds invested by private individuals or mortgage pool funds. Just like you’re interested in making money by investing your sweat equity in rehabbing and flipping a property, other people are interested in making money by investing funds to help you. The types of investors who can participate in these investments don’t get the same protections under the law as do consumers and shareholders. The result is that both hard money lenders and borrowers have more flexibility as to what a loan package looks like. Furthermore, since all three players in the HML loan are looking for a good return, HMLs have a vested interest in the loan performing to benefit all parties involved.
Keeping in mind this critical distinction is what allows HMLs to be more flexible than banks, here’s a closer look at how and why private lenders finance loans that banks are afraid to approve.
Why would you need a hard money lender?
Banks have strict underwriting standards. Their lengthy, complicated application process is the mechanism by which they do their due diligence to ensure that a potential borrower meets their strict underwriting standards. There are four general situations for which the bank’s approach to lending doesn’t work for borrowers.
- Timing: Some opportunities won’t wait. If you need to move quickly to buy the property, you can’t wait for the six to eight weeks for a bank to get through their application and disbursement process. HMLs can act quickly. For example, average turn-around time for BMC is two weeks. In some cases, BMC has disbursed funds in just a one day of having a complete file (e.g. title is ready, the borrower has provided all required information).
- Collateral: As a borrower, generally the more distressed a property is the deeper the discount you will achieve on purchase. Banks see those same properties as high risk and are reluctant to make loans to purchase them. In other cases, especially in the commercial real estate space, the value of the property may be too low to interest a bank. A bank has fixed costs to originate and service a loan, so the bank’s margin is bigger the larger the loan.
- Proceeds: HMLs typically will provide a higher loan amount. Banks will usually base their loan amount on the current value of the property. Both you and an HML are focused on the after-rehab value (ARV) of the property. Many HMLs base their loan amount determinations on the post-improvement value of the property, which is higher than its current value. Having access to a higher loan amount is a way for borrowers to use the loan to fund the rehab, instead of having to pay out of pocket for the rehab.
- Credit: Some borrowers have credit scores that don’t meet a bank’s underwriting standards. Even if the credit score is acceptable, a borrower may have another red flag in their financial history, say a bankruptcy in the past few years, that banks use to disqualify them. HMLs are more concerned with the potential of the asset, not the history of the borrower. The HMLs underwriting standards are about the current state of the market where the property is located and the potential ARV of the property to compete in the market. Thus, HMLs will lend to borrowers that don’t meet bank lending standards.
Looking through these different circumstances, you can see where working with an HML instead of a bank creates more opportunities. Maybe you need more money than the bank will offer on the property or that your credit qualifies you for. Perhaps you need to jump on a hot property fast; a bank just isn’t as nimble and either you don’t have or don’t want to use your own capital. The permutations of these four scenarios are infinite, but the end is always the same: The HML can step in and offer an attractive loan package that a bank can’t or won’t.
Advantages of using an HML over a bank
The above discussed the reasons why you might need an HML. Here are some of the reasons why you want to work with an HML, regardless of whether you’d qualify for a bank loan. It all comes back to the HML’s flexibility. There’s the flexibility an HML has to quickly approve loans, provide bridge loans, increase the loan amount to cover rehab/repair costs, and customize the structure of the loan. Another important reason is an experienced HML can save you time and money by providing valuable insight on the viability of your proposed investment.
HMLs will also often require less of a down payment from the borrower, which is a huge advantage. The HML considers the ARV of the property when determining the borrower’s down payment . Consider a property with a sale price of $50,000 with expected rehab costs of $30,000 and has a projected resale value of $100,000. A typical HML lender could loan the borrower $70,000 because it’s looking at the resale value. In this scenario, the borrow only needs a down payment of $10,000. Not a bad outcome.
Entrepreneurial lending vs. risk-management lending
Banks aren’t in the business of real estate development. They get low-cost money they want to loan out for low maintenance, predictable returns. HMLs are experts with the markets and assets they lend to (the valuable HMLs are, anyway) that seek an entrepreneurial return for their borrowers, their investors and themselves. They get involved with their borrowers to ensure the project goes well for everyone. Some hard money lenders, like BMC, truly value the relationships they have with their borrowers and investors, and seek to add value in hopes of an ongoing productive relationship and future business.
Now that you understand how an HML can provide value, learn more about what to look for when selecting a hard money lender for your real estate or land project.
About Bay Mountain Capital:
Bay Mountain Capital has been in business for more than a decade, closing approximately 2,000 loans over that time period. We specialize in financing all types of residential and commercial property investments throughout Texas. Using a common sense and value added approach, we strive to incorporate these principles into our underwriting and closing processes. We are a Dallas Hard Money Lender, but we do business in Austin, Houston and beyond!
As a direct lender, Bay Mountain Capital can close a loan within one day after receiving clear title and a complete file. The process generally takes from two to three weeks, but can be accelerated where circumstances require it.
We are an asset-based lender, which means that qualification requirements are limited. Our rates and fees are among the lowest in the industry.