Need a Construction Loan? Consider Hard Money Lending

Both in the today’s print edition and on its real estate blog Developments the Wall Street Journal discusses the concept of hard money lending.

As many developers already know, hard money lending is not the dark underbelly of the lending world where loan sharks swarm.  Instead, hard money lending is interim financing similar to a bridge loan.  Hard money loans carry a higher interest rate than conventional financing and have terms that can last as short as a few months.  As the Journal notes,

Hard-money lenders don’t focus much on a borrower’s credit scores. They care more about asset valuations and loan-to-value ratios. Many lenders won’t lend more than 50% to 70% of the home’s value, while banks will lend as much as 80% and government-backed loans can go as high as 96.5%.

Those with shoddy credit are not the only ones that turn to hard money lenders.  Many, who are otherwise creditworthy, but that cannot qualify for traditional bank financing for not credit related reasons, such as current property values or cross collateral restrictions, often turn to hard money lenders.  When the project is completed, these creditworthy borrowers will refinance the hard money loan with traditional bank financing.

For example, consider a developer who may have several mortgages with a traditional bank.   The developer locates a depressed property that it feels can be rehabilitated and flipped for a profit.  The property may literally be depressed – as in the verge of collapse – or the developer may have acquired the property through a foreclosure or short sale.  In any event, the appraised value of the property in its current condition will not support a loan to value ratio sufficient for the developer’s traditional lender to extend it financing for the acquisition and construction of the property.  Or, the developer’s lender’s internal lending guidelines have changed and it no longer makes loans secured by the type of project the developer is proposing.  The relationship between the developer-borrower and the lender may be great and the developer’s loans may all be performing, nonetheless, financing is unavailable.

In this situation, a short term hard money loan is attractive to a developer.  The developer can quickly acquire the property and complete construction.  After completion, the developer will pay back the loan with traditional financing.

Obviously, using hard money for development can be tricky.  First, a developer needs to be sure that the construction can be completed before the hard money loan matures.  Many hard money lenders charge a hefty “roll over” fee if short term loans are not repaid at the end of the term.  Second, a developer needs to be certain that the finished project will have an appraised value sufficient to support traditional financing.  Otherwise, the developer may be stuck with paying a high interest loan to carry the project or, in the worst case scenario, losing the project to a foreclosing hard money lender.

Despite its unearned unsavory reputation, hard money lending can prove to be attractive to developers in unique situations.  For those interested in learning more about hard money lending and borrowing, I hope to have an interview with a hard money lending specialist up in the next few weeks, so be sure to check back.

 

Comments Email Tweet Like LinkedIn