Hard money lending can be a fantastic short-term solution for real estate investors that need cash quickly, easily, and with a variety of terms and payment schedules. While many lenders are considerate of the borrower’s specific situations, they also have a responsibility to their investors to protect their money at all costs, which means acting appropriately when a borrower defaults on a debt.
There are several situations that can cause a borrower to default and the terms can change wildly from loan to loan. When taking out a hard money loan, it’s best to understand the terms and conditions specific to that individual agreement.
The following is a list of all the reasons a borrower could default on a hard money loan:
Missed Payment – Due to the short-term nature of a hard money loan, a simple missed payment could be all that’s required for the lender to call the loan as due.
Missed Balloon Payment – Nearly all hard money loans come with a balloon payment that is much larger than the individual monthly payments and is due at the end of the agreement. Generally, the borrower is able to make this payment due to the sale of the investment property, but if they can’t for whatever reason, the lender may foreclose on the property.
Changing Conditions – Depending on the terms that the loan was originated with, different financial conditions on the part of the borrower can be enough to convince the lender that they need to call the loan due immediately, rather than later. This process isn’t as arbitrary as it sounds, but if the loan is called legally and you’re unable to pay, it can be cause for default.
Deterioration – If the condition of the investment property deteriorates to a level below a threshold deemed acceptable, the lender may foreclose on the property or ask for an advance of funds.
Illegal Transfer – Some contracts stipulate that the borrower must keep the property in his name. Unauthorized transfer of the property could result in a default of the loan as well, along with certain penalties.
What Happens if I Default On My Loan?
Due to the truncated nature of hard money loans, the average lender may choose to call the loan quicker than average traditional lenders, but there are still a few steps before total foreclosure.
For starters, a default or missed payment may cause the lender to increase the interest rate on the loan substantially; in some cases, even up to double. Hard money loans have interest rates that are much higher than average loans – they usually begin at 12% and go up from there – so a default can increase it to 25-30%, or even higher. A payment of $1500 can go up to $3000 or even higher, making it nearly impossible for the borrower to make the bill current. If it stays in default, the lender may choose to move on to more drastic measures.
A foreclosure occurs when the bill is called due and the borrower is unable to pay. In this event, the borrower will most likely decide to sell the collateral and keep all of the current payments as a penalty for loan default. If the borrower is close to the end of the life of the loan, this could mean several thousand dollars that are simply lost. In most cases, hard money lenders do not report a default to credit bureaus due to the cost, but they may choose to do that as well.
Another option for the borrower is called “deed in lieu of foreclosure.” If the lender accepts, the borrower may give the property back to the lender instead of having a foreclosure appear on their record. Too many foreclosures can affect the borrower’s ability to secure a traditional loan in the future, although borrowing from another hard money lender may be an option. If the borrower pursues a deed in lieu of foreclosure, they must be sure to gain a release from the lender, or else they could be on the hook for the property and the loan as well.
Dealing with a hard money lender can be a great experience, but as with anything financially-related, it also comes with some dangers as well. The end goal of any money lender is not to acquire property that they will then have to resell since they make money on the interest itself, but they have a right to protect their own investment through any legal means necessary.