What Is Hard Money

A hard money loan is a specific type of asset-based loan financing in which a borrower receives funds secured by the value of a parcel of real estate. Hard money loans are typically issued at much higher interest rates than conventional commercial or residential property loans and are almost never issued by a commercial bank or other deposit institution. 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.

Many hard money mortgages are made by private investors, generally in their local areas. Usually the credit score of the borrower is not important, as the loan is secured by the value of the collateral property. Typically, the maximum loan to value ratio is 65-70%. That is, if the property is worth $100,000, the lender would advance $65,000-70,000 against it. This low LTV provides added security for the lender, in case the borrower does not pay and they have to foreclose on the property.

Loan structure

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 or second 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 60-70% 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 timeframe. 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

History

Hard Money is a term that is used almost exclusively in the United States and Canada where these types of loans are most common. In commercial real estate, hard money developed as an alternative "last resort" for property owners seeking capital against the value of their holdings. The industry began in the late 1950s when the credit industry in the US underwent drastic changes (see FDIC: Evaluating the Consumer Revolution).

The hard money industry suffered severe setbacks during the real estate crashes of the early 1980s and early 1990s due to lenders overestimating and funding properties at well over market value. Since that time, lower LTV rates have been the norm for hard money lenders seeking to protect themselves against the market's volatility. Today, high interest rates are the mark of hard money loans as a way to compensate lenders for the considerable risk that they undertake.

Hard money rate

Hard Money Mortgage loans are generally more expensive than traditional sub-prime mortgages. However all mortgage loans are not necessarily considered to be a high cost mortgage. Generally a hard money loan carries additional risk that a borrower is aware of. Rather than selling the property a borrower will opt to keep the loan and if a lender is willing to assume some of the risk by offering a hard money loan.

Interest rate on hard money

The rate is not dependent on the Bank Rate. It is instead more dependent on the real estate market and availability of hard money credit. As of 2007 and for the past decade hard money has ranged from the mid 15%-25% range. When a borrower defaults they may be charged a higher "Default Rate". That rate can be as high as allowed by law which may go up to or around 25%-29%.

Hard money points

Points on a hard money loan are traditionally 1-3 more than a traditional loan, which would amount to 3-6 points on the average hard loan. It is very common for a commercial hard money loan to be upwards of four points and as high as 10 points. The reason a borrower would pay that rate is to avoid imminent foreclosure or a "quick sale" of the property. That could amount to as much as a 30% or more discount as is common on short sales. By taking a short term bridge or hard money loan, the borrower often saves equity and extends his time to get his affairs in order to better manage the property.