How Hard Money Lenders Are Different From Traditional Lenders

We receive many phone calls from potential borrowers daily. Some are very familiar with hard money lending and have already financed several properties using hard money loans. Others are new investors with questions like, “What are hard money lenders?” “How are they different from other sources of financing?” “How can hard money loans help me make money?” If you’ve never worked with hard money lenders before and have the same questions, read on.

We are all familiar with traditional lenders. They include your local bank, national lender, credit union, or neighborhood mortgage broker. The majority of their mortgage business comes from underwriting consumer mortgage loans or mortgages on primary residences.

Fannie Mae and Freddie Mac are the largest guarantors of consumer mortgage loans in this country. It means that traditional lenders have to follow their general guidelines when deciding whether a consumer can qualify for a mortgage. Consumer lending is a highly regulated industry, and for good reasons. The memory of the housing crisis of 2008-2010 is still fresh in our minds: it started with loose underwriting standards that led to making high-risk loans to borrowers who couldn’t afford them. Since then, traditional lenders have gotten rid of many programs and tightened their loan qualification standards. To get a conventional mortgage, borrowers now need to have more income, more savings, and better credit. Because of government regulations, it also takes longer to get a loan. If you’ve recently purchased or refinanced your home, it probably took two months to close your loan and an overwhelming amount of paperwork.

The easiest way to begin understanding who hard money lenders are is to know the critical differences between them and traditional lenders. There are at least three.

Hard money lenders do not lend on primary residences.

Hard money lenders are not here to promote homeownership. They are here to promote entrepreneurship. This is why they do not lend on primary residences. Loans that finance primary residences are typically referred to as consumer loans and are subject to regulations from both financial regulators and consumer protection watchdogs.

The purpose of those regualations is to ensure that consumer loans are sustainable in the long term (think 30-year mortgage) and that consumers are not charged exosperant fees or offered unfavourable terms. Essentially the government is protecting consumers by limiting their financing choices.

In contrast, hard money lenders work with business people and not consumers. Hard money financing offers an opportunity to those business people to make profits by purchasing and renovating distressed properties. The government stays out of regulating such mortgages because they are essentially a contract between two business entities. A hard money lender can make any type of loan that fits its risk appetite and charge for it accordingly.

This is why the majority of private hard money lenders prefer to lend to borrowers in the name of their LLC’s. By borrowing to LLC’s, they remove any ambiquity regarding the nature of the transaction (it’s a business lending to another business) but also allows for extra protection of the collateral against future of existing liens or lawsuits. For more information on the subject, please refer to our article about why hard money lenders love LLC’s and why you should too.

Hard money lenders do not sell their loans.

Larger institutional lenders have rigid underwriting criteria because in the majority of cases they do not hold on to their loans. Once those loans are originated, they are packaged together and send to another lender or a mortgage guarantor such as Fannie Mae or Freddie Mac. To be a part of the portfolio being sold, they need to fit criteria specified in adance by the buyer of that portfolio.

Hard money lenders typically retain their loans after the origination. Some – including New Funding Resources – lend their own money or money they raise from their capital investors. They decide which loans to fund based on their own risk tolerance and lending experience. At New Funding Resources, for example, we do have general underwriting guidelines, but can make exceptions to them if our undertwriters feel that those exceptions are warranted.

Hard money loans are typically short-term loans.

Unlike consumer loans, hard money loans are not designed to held for fifteen or thirty years. Their typical term is between six to eighteen months before they need to be repaid either by flipping the property or refinancing it.

To summarize, hard money loans are not here to help borrowers purchase a primary residence. The purpose of hard money is to help real estate investors make profit by providing a unique source of funds to buy, rehab and sell a property. There are three major reasons why, without hard money lenders, real estate investing would be limited to those with deep pockets.

Many investors would simply not qualify for a loan.

Some folks don’t have a sufficiently high credit score, have dings on their credit, or do not show enough income to qualify for a traditional loan. Others would be turned down by their bank because they already have too many mortgages. Without hard money financing, these borrowers would have no choice but to sit on the sidelines and watch other people make money.

Many properties would not qualify for financing.

Traditional lenders typically base their loans on a current condition of the property. With few exceptions, they lend to consumers, not rehabbers, so they require a property to be “livable” right away. They don’t want to lend on properties that are damaged, trashed or don’t have a functioning kitchen or bathrooms. Hard money lenders focus on the property’s potential or what it can be once an investor finishes up its rehab. For example, at New Funding Resources we base our loans solely on the after-repair value of the property.

No ability to compete with cash offers.

A great investment opportunity often comes with a seller who is either under time pressure to sell or needs to close with a minimum hassle. An all-cash offer is hard to compete with – unless you are working with a hard money lender. No distressed seller would wait sixty days for a bank to approve a loan. In contrast, a good hard money lender should be able to fund a loan within a week or so. Because of their speed, hard money loans are widely considered equivalent to all-cash offers. In short, they level the playing field between the investors with significant liquid assets and those without.

Hard money loans are not for everyone and not everyone will qualify for them either. However, for many investors, they offer a fast and nimble source of capital not available from traditional lenders.