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Jack M. Guttentag The Mortgage Professor

These Are Good Times for Hard-Money Lenders

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Good (238 Ratings): 2.7521/5

Posted on Monday, November 10, 2008, 12:00AM

Like all disasters, the financial crisis has its share of beneficiaries who profit from it. The hard-money lenders, who lend strictly on the basis of collateral, have profited from the financial meltdown. These non-institutional lenders require a lot less paperwork than institutions because they don't worry about whether or not borrowers can afford the payments, or whether or not they are creditworthy. They don't bother with income, employment, or credit reports.

If borrowers can't pay, the hard-money lenders get their money back through foreclosure. They typically require 30 percent to 35 percent down to make sure that there is enough equity available to cover foreclosure expenses. Interest rates are much higher than those charged by institutions, and terms are short.

The earliest mortgage lenders of the 19th century were focused entirely on the collateral. Through necessity, they were hard-money lenders. There was no way to document anyone's income in those days, and credit reporting had not yet emerged.

Lending Over the Decades

Over the decades, loan underwriting increasingly came to emphasize the capacity of borrowers to repay their mortgage as indicated mainly by their incomes relative to their expenses, as well as their willingness to repay as indicated by their credit record. Rules regarding how both the capacity and willingness to pay had to be documented came to fill many pages of underwriting manuals. As collateral became less important, down payment requirements declined and, in many cases, disappeared entirely.

Hard-money lending today is thus a throwback to the era before the capacity and willingness of mortgage borrowers to repay became important parts of loan underwriting.

The financial crisis has been good for hard-money lenders because it has made loans with less than complete documentation of income and assets extremely difficult to obtain from institutional lenders. Here is a recent example from a letter I received:

"I bought my permanent residence for $300,000 in 2005, paid all cash, but now I need $80,000 to make repairs and can't find a loan. I live off the income from other properties that I own, but I show very little income on my tax returns because most of it is shielded by depreciation and interest costs. None of the lenders I have approached will give me a loan."

Before the crisis, this borrower would have had no difficulty finding a "stated-income loan", meaning one where the borrower stated his income but was not required to document it. Indeed, the stated-income loan was designed to meet the needs of exactly this type of borrower. The interest rate would have been only .25 percent to .5 percent higher than the rate on a fully documented loan.

But as underwriting rules loosened during the go-go years of 2000 to 2006, stated-income loans came to be called liars' loans because they were so often used to qualify borrowers for mortgages they could not afford. The presumption was that rising home prices would allow them to refinance to a lower rate later on or, if necessary, to sell the house at a profit. Instead of reflecting real income that could not be documented, stated income often reflected income that did not exist.

As the financial crisis emerged and foreclosures mounted, hostility against liars' loans grew. The notion took hold among regulators, legislators, and even many loan providers that every mortgage borrower should be required to document their ability to repay the mortgage. While, to my knowledge, none of the attempts to enact this rule into law were successful, the market's response to the crisis has essentially done that job. Stated-income loans have become difficult or impossible to obtain from institutional lenders.

So I had no choice but to advise the letter-writer above to find a hard-money lender. The rate premium, relative to the cost of a documented loan from an institutional lender, will be much higher than .25 percent to .5 percent. As partial consolation, there are a lot of these lenders out there.

Hard-money loans should be relatively easy to shop because their rates don't bounce around from day to day, as they do in the institutional market. I don't have any experience with this market, however, and readers who have taken loans from hard-money lenders are invited to let me know how they did.

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189 Comments

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miami123 - Saturday, December 6, 2008, 2:06PM ET Report Abuse
- Overall: 3/5
Hi, I purchased a foreclosure in Miami in 2007 with a regular NIV mortgage for 30 years,I remodelled it using mainly credit cards,since the market has gone down,I rented it out instead of trying to sell it,no-one is buying,at least the rent is covering my monthly payments.Since then I have found many deals here in Miami that need only minor rehab,but unable to get financing from the bank,since I have 2 mortgages and NIV loans are not available.I have contacted couple of hard money lenders,but they don't loan with no money down.If you are a lender or can refer me to one, who will still loan with no money down,please e-mail me at cerroazul_pe@yahoo.com
NonovY - Wednesday, November 19, 2008, 7:57PM ET Report Abuse
- Overall: 1/5
This doesn't tell me anything I didn't already know. What would be more interesting would be to see what mortgage rates were for borrowers with good credit in prior deep recessions. It seems to me that they are way too high right now. Lenders are still licking their wounds and hoarding cash while the economy is falling off of a cliff.
mel - Monday, November 17, 2008, 11:41PM ET Report Abuse
- Overall: 4/5
I WAS A HARD MONEY LENDER FROM 1971-1984. WE LOOKED AT CREDIT AND INCOME, BUT REALIZED THAT COULD ALL CHANGE WITH IN MONTHS, AND THEREFORE WE NEEDED GOOD EQUITY. DURING THE CARTER YEARS WE WERE GETTING A 10 POINT LOAN FEE AND 22% INTEREST. WE HAD HIGH APPRECIATION, BUT NOTHING LIKE THE LAST FEW YEARS. I STILL INVEST IN THESE AND CURRENTLY GETTING 10.5 TO 12.5% INT ONLY.
Mark - Monday, November 17, 2008, 11:22AM ET Report Abuse
- Overall: 4/5
Maybe you will be interested to hear an actual case: I am not regularly in this business, but I made a hard money loan of $100K with a small commercial building as colateral. This is a first loan and the building was assessed at $400K when I made the loan. The loan was supposed to be paid off after 6 months. He paid 12% interest up front. After 6 months, he did not pay back the $100K. I did this loan through a broker and she dragged her feet about starting the foreclosure because this borrower was a long time customer. 5 months into default, we have finally started foreclosure. The property is now worth about $250K, so I will likely get my money back at the auction. The borrower just totally blew it. He could have easily sold the property for $350K at the time he defaulted on the loan, but went into denial, gave me lots of stories and excuses and will now lose a lot of equity. He owns many properties and has refused to sell any of them. The thing that galls me about all the reportage of the foreclosure phenomenon is that all the sympathy goes to the borrower, never the lender. Foreclosure is an essential part of the lending system. Without it, liquidity is diminished and the cost of loans goes up for all borrowers. Because of the experience I had with this bad borrower, I am going to charge more interest on the next loan. If you want to restore the health of lenders and cure the credit crunch, speed up foreclosure, don't slow it down. Let the lenders get their money back so they can lend it again.
Alan - Monday, November 17, 2008, 8:43AM ET Report Abuse
- Overall: 3/5
Even in the times of easy credit and stated income it was difficult for us to get loans. Our debt to income ratio was too high. Our credit, however has remained excellent. The hard money lenders do charge a little more, but if you read the contracts the worst part is that the borrower has very little protection from unscrupulous lenders. The other part is the amount of equity required to secure the loan. One had best not make a misstep. There is one other source for developers and others in the real estate business. If one can find a private lender familiar with the business they will often lend with little or no up front costs and at an interest rate very reasonable compared to commercial rates. They normally take a fifty percent equity position and fully evaluate the project with a level of knowledge and experience unequaled in the banking industry. Problem here is limited funds and you have to catch them when the money is available. For now we can probably forget about the major banks. BB&T told us they are not interested in lending on equity. They are primarily lending on revenue stream, and then very cautiously. Doesn't that leave an opportunity for a smart lending institution to step in and address that market? We hope so.

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