The definition of Hard Money Lending is fairly simple: a Hard Money Loan is a loan of “last resort” or a short-term “bridge loan.” Bridge Loans are loans of short-term duration that are typically a temporary solution to longer term financing from more customary or traditional lending sources, such as a bank. Hard money loans are backed only by the value of the property, most often real estate, not by the “credit worthiness” of the borrower. Since the property itself is used as the only collateral against default of the loan by the borrower, hard money loans have lower loan-to-value (LTV) ratios than traditional loans.
Loan-to-Value (LTV) is the amount of money borrowed as a percentage of the property’s value.
Hard Money has several defining characteristics:
- Based on the value of the property
- Short Term (6 – 12 months)
- High Interest (8 – 17%)
- High loan “points” (cost to get the loan)
- Often do not require income verification
- Often do not require credit references
- Quick ability to fund
- O.K. with property in poor condition
Today, investors are looking at alternative investments to the stock market that generate income from interest, particularly when savings accounts offer less than 1% return on your savings. These investors may become a part of an investment pool for a borrower that is developing or fixing up a property to be sold. Conventional lenders such as banks and credit unions will generally not loan money on these types of transactions, therefore the developer has to capitalize his construction property via personal capital or from “OPM” commonly known as “other people’s money”. This can become an expensive funding mechanism for the developer/borrower because of loan origination fees, processing fees, points, closing fees, and periodic interest that must be paid to the lenders. Some Hard Money Lenders also charge “Extension Fees” that are paid not to the lender who has its money at risk, but to the hard money mortgage broker(s).
A title policy and appraisal are ordered, a first, second, or third lien note is generated and often times assigned to the collecting agency or mortgage broker servicing the loan. The loan or promissory note is always accompanied by a mortgage—called in Texas a “Deed of Trust” or in California a “Trust Deed”. Whatever term the mortgage is called, it serves the same purpose—to protect repayment of the loan.
The investor/lender should closely review any statements made and promotional materials presented by the broker and perform their own due diligence to determine if the representations are correct. Consider driving by the property to review the progress and judge the stage of completion. A background investigation should be considered on the developer/borrower to determine his/her experience, knowledge, and skills at completing the project for which the money is loaned.
The investor/lender cannot rely on the representations of any broker. It is the lender’s money and the broker wants a piece of it. Promises that the brokers may make ensuring that they will perform their “due diligence” are meaningless. Their main motivation is for a deal to close so they earn their fees, similar to any real estate broker in a normal buy/sell transaction.
An investor/lender should be aware that unless there are specific provisions in the Promissory Note relating to the specific use of the funds, that it is commonly thought that the funds “can be used for anything the borrower desires.” Language such as, “The proceeds of this note shall be used only to pay contractors and subcontractors for work performed in connection with the property unless (and only to the extent that) the holder of this note has approved in writing another purpose or purposes“ should be included.
Provisions such as, “The Maker warrants and represents to Payee and all other holders of this note that all loans evidenced by this note are and will be for business, commercial, investment, or other similar purpose and not primarily for personal, family, household, or agricultural use” should be written as tight as possible because the lender’s money could easily be used for materials on other jobs, for the purchase of other assets, for personal use, and not for the completion of the construction or fix-up.
But language in a Note, being a piece of paper, can and often is meaningless. An old Louisiana country lawyer told a very honest and honorable friend of mine, any piece of paper, including anything in writing, is only as good as the person’s integrity making the promise.
Hopefully your investor/lender clients involved in Hard Money lending will have an attorney involved in the matter that is well versed in the Hard Money lending business. It is definitely not an area for a novice. There are opportunities for the investor/lender to lose his principal and incur additional expenditures to protect his position by foreclosing on the property. Many Hard Money loans end up in federal bankruptcy court. Sage Investigations has the experience with just these cases, and will gladly consult with you and your client on specific instances that will provide you with concrete evidence of the possibility, or, indeed, probability, that your Hard Money loan will end up wiped away in federal bankruptcy court.
Be aware, this information should cause all participants engaged in Hard Money lending activities to take a pause. Consult a lawyer that is solely responsible to you or your client and that has no conflict of interest with the hard money lenders/brokers. Often times, this conflict is over-looked or conveniently ignored just to get the deal done quickly. Haste and legality often times don’t match.
Once the person has spent the money on activities outside of the purpose for which the loan was made, you will have a problem and then it’s too late. Foreclosure and litigation will drain ever more of your client’s resources, and can exceed the original amount of their investment.
Your client has to get it right up front, or they are destined to fail.
Sage Investigation LLC is standing by to assist you and your clients, by performing due diligence, and if necessary follow the money if the hard money is not used for its intended purpose. You or your client can contact Sage for an investigation, and any litigation support necessary. Sage can also provide expert witness testimony. Call Sage Investigations LLC at 512-659-3179 and let our 26 plus years of IRS experience work for you.
1 In some states that have no interest ceilings or very high interest ceilings, such as Arizona and Delaware, legal rates of interest may exceed what would commonly be considered usurious. Take for instance bank credit card rates charged to customers with bank subsidiaries based in Delaware charging customers 28%.