Financial scams are life’s unfortunate reality, and hard money scams are no exception. As the hard money industry matures, the number of entities that engage in questionable ways of doing business goes up. Unscrupulous practices might range from false advertising and interest-rate bait-n-switch to collecting substantial upfront fees and then refusing to fund a loan.
What makes things complicated is that unlike consumer financing, the hard money industry is not overly regulated. One advantage of that is that private lenders can choose whichever level of risk they’re comfortable with and the compensation that makes taking this risk worthwhile. In other words, no one tells private lenders what kind of business loans they can and cannot accept and how much or how little they need to charge for those loans. Those decisions are primarily driven by market forces of supply and demand rather than a government agency.
The challenge for the borrower comes when shopping for the right product and the right hard money lender to work with. Unlike cookie-cutter consumer loans, each hard money loan is a loan based on the unique characteristics of each borrower and each property. How do you compare apples to oranges and, for that matter, to cherries and cucumbers? We get many calls from aspiring investors who diligently read from the list of questions I presume they have received from a real estate seminar. What are your rates? What’s your underwriting fee? How fast you can close? How much I need to bring to closing? Since there is no regulation of what private lenders can or cannot do and, subsequently, no strict disclosure requirements, it’s tempting to tell them what they want to hear. I suspect the best lender in their mind would be someone who promises (1) the lowest interest rate; (2) no underwriting fee; (3) closing tomorrow or sooner; (4) no money down.
Unfortunately, many lenders do just that – quote whatever you want to hear. “Heck, – their thinking goes, – throw any terms there – however preposterous they are – just to tell those suckers that they don’t qualify for them a day prior to closing. The truth of the matter is that there is always an excuse one can use to deem those borrowers ineligible down the line. Here is Jesus, our borrower. Jesus works on water, that’s true, but he could not qualify for the best rates because he could not prove that he has walked on water at least 20 times in the last 16 months. Sorry, Jesus, and best of luck next time.
The lack of initial transparency inherent in private loans and the lack of accountability for quoted terms create enough smoke and mirrors to mislead the most diligent borrowers. In the majority of cases, it’s hard to judge a private lender unless you’ve navigated through the entire process with them. However, there are warning signs and there are steps you can take to make sure that you would not fall victim to hard money scams
Hard Money Scams: the Four Sure Signs That Something is Rotten
Hard Money Scam #1: Large upfront fees
Hefty upfront fees are highly unusual in the private lending industry. To be honest, few reputable hard money lenders – including New Funding Resources – would charge anything upfront (with a notable exception of appraisal fees paid to the third party). Upfront fees are often called commitment fees but can be referred to by any other name your hard money lender chooses. If a lender you’re working with charges upfront fees, it should be considered a serious warning sign.
Hard Money Scam #2: Sending the funds directly to the lender
Never send the funds required for closing – no matter if they’re your contribution towards the purchase or closing costs of any kind – to any party other than a title company. A title company distributes the funds to and from the parties involved in real estate transactions. It also ensures that each element of the transaction is handled per the existing real estate laws. As a private lender, I recommend that you choose your own title company to handles your transaction.
Hard Money Scam #3: Aggressively advertising low rates.
If something is too good to be true, it usually is. Or, as my personal favorite saying goes, free cheese is only offered in mouse traps. While it’s essential to ensure that your loan is competitively priced, you should steer away from lenders that aggressively promote steeply discounted rates. As I write this blog, there are several ads run by an out-of-state competition that advertize rates are simply ridiculous. How do I know? Because we haven’t met anyone yet – no matter how experienced – who was able to qualify for them (and we know quite a few who’ve tried). Another reason I know is that these firms are spending quite a bit of money on their advertising. If any private lender were offering rates like that, they would have no need for such marketing spend. A word of mouth alone will be enough to bring them as much business as they can handle. What gives?
Hard Money Scams #4: Intentionally confusing fees and points structure.
Each hard money lender has its own fee structure and might refer to different cost items by different names. However, the majority of borrowers on the comparison-shopping spree require only about points. A lender might inform you that they charge only X points but “forget” to mention that their underwriting and other fees run thousands and thousands of dollars making your lender comparison efforts rather useless.
Ready to cut through smoke and mirror? Learn specific actions to take to avoid hard money scams and choose the right private lender that propels your business forward. Read our next blog here.
New Funding Resources is a private hard money lender that offers private financing to the real estate investors in the DMV area. Whether you’re investing in Manassas, VA or Montgomery Village, MD, we’ve got you covered. Call today at 240-436-2340.