Private lenders (alternatively referred to hard money lenders) are a narrow subset of mortgage companies that specialize in working with real estate investors. The financing that they offer is asset-based. As the name suggests, asset-based financing is financing that is secured against an asset or collateral. Asset-based financing has a long history that goes back to ancient times when almost anything of value could serve as collateral. In modern times, the most common assets for businesses to borrow against are accounts receivable financing, inventory financing, equipment financing, or real estate financing. Our focus is asset-based lending for real estate investors.
How are asset-based loans different?
Any type of mortgage is asset-based to a certain extent. If you own your own home, chances are that you have a mortgage on it. If you fail to make payments, your lender has a right to foreclose on your home and pay off your debt by selling it. Your home is an asset that you pledge to your lender for the duration of your loan. Though any type of mortgage is technically asset-based, the term asset-based lending in real estate usually implies that the loan is made exclusively for business purposes. The most obvious example of such a business purpose is to make money by fixing-and-flipping dilapidated homes.
Since the purpose of private or asset-based loans is different from conventional loans, so is their underwriting. For a conventional lender, borrower’s credit and income are two key parts of their underwriting. They want to make sure that the borrower is capable of sustaining mortgage payments in the long term. If your debt ratio is too high or your credit score is too low, they might deny you no matter how much equity you have in your home.
Asset-based loans are typically short-term, providing business owners with sufficient funds to move from point A to B. This is why they often referred to as “transactional funding.” For example, they provide real estate investors with the financing they need to purchase and renovate a home. Once the renovation is completed, a private asset-based loan must be repaid either by selling a property or refinancing it with another lender. In such cases, credit or income may play a less important role. In other words, a private lender might be able to overlook credit or income issues if an asset pledged as collateral offers sufficient protection of the lender’s interests.
What diffentiates one asset-based lender from another?
Of course, the risk appetite varies from one private lender to another and it’s reflected in how they make their underwriting decisions. Real estate asset-based lending is a relatively unregulated industry that leads to a variety of products and programs. Some private lenders have minimum credit score requirements and some don’t. Some verify borrower’s income and some are not that concerned about it. Many private lenders choose not to work with their first-time investors believing it increases their overall risk. Others (New Funding Resources among them) developed well-performing programs to accommodate their needs. However, despite their differences, all private lenders are focused on whether the property you are pledging as collateral can safely and efficiently secure their interest.
What makes good collateral in asset-based lending?
Real estate asset-based lenders love equity. Equity is determined by subtracting all the debt secured against the property from its value. In conventional financing, lenders use the current value of the property. To give you maximum leverage, many private lenders base their loans on the after-repair value of your property and not on its existing market price. The most obvious example of an awesome asset is a property that doesn’t have any current liens on it. Supposed you’ve inherited a property from your grandmother. It’s mortgage-free and is currently worth $200K. You want to renovate it before selling it and need to borrow $50K to do so. Congratulations, from the asset-based lending perspective, your collateral is practically bursting with equity.
Let’s take a look at another example of a strong collateral. Supposed you have an opportunity to purchase a distressed property for $250K. You estimate that after investing $60K in its renovation, it’s after-repair value would $415K. I don’t want to talk for other companies, but as an asset-based lender I would be willing to advance the funds needed to purchase such property as well as finance at least a part of its renovation.
Typically, asset-based lenders in real estate can lend both on residential and commercial properties.
What types of real estate collateral are problematic for asset-based lending?
Properties with little equity are less attractive for an asset-based lender. If you’ve inherited a $200K house from your grandma, but she had a reverse mortgage on it with the balance of $190K, you only have $10K in equity. You might have difficulty qualifying for a private loan even if your renovation would increase the home value to $300K.
The vast majority of private lenders also prefer to be in the first-lien position. They don’t allow second mortgages because they erode the equity that the asset-based lenders count on to secure their interest. In addition, asset-based lenders might be hesitant to finance a property the value of which is uncertain or speculative. For example, it might be difficult to evaluate the value of a church located in a residential neighborhood or a small retreat center located in a rural area.
How to evaluate the value of my collateral from the asset-based lending perspective?
Since asset-based lenders love equity, the more equity you have the better. Simply put, private lenders like us want you to get as good of a deal as possible. That means buying below market, maximizing the impact of rehab while controlling the costs, and selling for the highest price the market would bear. These three numbers – the purchase price, the rehab cost, and the sales price – are the anchors your business transaction is based on. However, determining the profit is not as easy as subtracting your purchase price and rehab costs from that future after-repair value.
To make sure your transaction makes sense for an asset-based lender, remember to include all costs associated with it. The best way to do this is to use a hard money calculator. There are many versions available but, of course, my preference is to use the hard money calculator developed by the New Funding Resources team. Its unique feature is the underwriting recommendations it generates. It’s like having an informal heart-to-heart conversation with an asset-based lender.
Another component of the analysis is determining the after-repair value. As a real estate investor, you must develop skills to evaluate the value of the property independently of your real estate agent. For practical information on how to effectively estimate ARV on your own, click here.
Would an asset-based lender be more motivated to take my property than a regular mortgage company?
Because asset-based loans are technically business loans, they don’t enjoy as many foreclosure protection mechanisms as consumer mortgages. That doesn’t mean that your lender is looking forward to foreclosing on you. Trust me, going through a foreclosure is a complex and time-consuming process. Any reputable lender would rather have a well-performing loan on their books than a loan that is in default.
That said, an approach of dealing with borrowers who are late on their payments or need to extend their term varies from one private lender to another. Some are more amenable to working with their borrowers to avoid foreclosure while others might employ a more aggressive by-the-book approach. The terms and conditions of how the loan should be repaid and what constitutes the default are disclosed in the closing documents such as the Note.
How to find a reputable asset-based lender?
Flipping homes in Ohio is very different than flipping homes in Washington, DC. Real estate is a local business and so should be your lender. Remember, an “asset-based” lender is a broad category that might include different types of collateral. The easiest way to find a reputable real estate asset-based lender is to look online by typing “private lenders near me” or “hard money lenders near me” in your search browser. Make sure to work with a business that both has high ratings and a high number of independent reviews. For more detailed information, read our blog on how to chose a private lender that is right for you.
Can I qualify for an asset-based loan if I don’t own a business?
The majority of private lenders would lend only to businesses. That doesn’t mean that you need to have a bustling company to qualify. Creating a limited liability company is easy and affordable. Aside from qualifying for a loan, there are many advantages to doing business in LLC’s name. You can read all about them here.
Asset-based lenders are lenders who work with businesses to provide them with short-term transaction funding. Their loans are secured against a specific type of asset. Asset-based lenders that use real estate as collateral are commonly referred to as private lenders or hard money lenders. Private lenders lend on distressed commercial and residential real estate that has equity or will have equity after the renovations. They employ a streamlined underwriting process and can close much faster than a traditional lender.