Hard money loans provide mortgage financing to borrowers who cannot qualify for a loan through a retail banking institution. Borrowers fail to qualify for conventional loans for several reasons. Sometimes the property is unique and therefore cannot be financed. Other times, the property has sustained damage and banks won’t finance it in the current condition. Most often, borrowers seek hard money because their credit history or income/job situation makes obtaining a conventional loan impossible.
Poor credit history rarely disqualifies borrowers from hard money loans. Some hard money loan lenders pay no attention to credit history at all when making loan decisions. Some give credit history a cursory glance. Others offer loans with higher interest rates or more points for applicants with poor credit histories.
Most hard money lenders approve loans based on the property, not the borrower. If you have sufficient equity in the property, you are very likely to gain approval for a hard money loan, regardless of your credit profile. Most hard money lenders approve loans based on the loan-to-value (LTV) ratio.
In today’s market, hard money lenders are generally approving loans up to 80 percent of the LTV. This means that if a property’s valuation stands at $200,000, a hard money lender will approve a loan of up to $160,000. A hard money lender often approves the loan even if the borrower has defaulted on the mortgage, has a very low credit score, has declared bankruptcy, or has no credit history at all.
Why do hard money lenders approve borrowers with poor or no credit?
Hard money loans are based on the property having sufficient equity. To grant the loan, the lender must have security, and in hard money loans, the equity in the property provides that security. If the borrower defaults on the loan, the lender can repossess the property and sell it for the full value. This allows the lender to protect himself against losing his investment if the borrower fails to pay the loan. In some cases, hard money lenders make a substantial profit on the sale of repossessed properties.
Since hard money loans are approved without investigating credit history or verifying income, they are automatically considered high risk. Because they entail an inborn propensity for default, hard money lenders charge a substantially higher interest rate than retail bank lenders. Hard money lenders also use a different criteria for determining interest rates.
Retail banks, including subprime lenders, base interest rates on a combination of factors, but credit history always plays an important role. Retail lenders often use a matrix to determine interest rates. The matrix includes the borrower’s FICO score and the LTV ratio. Based on these factors, the lender determines the interest rate. The lender also analyses the borrower’s income and outstanding liabilities, in order to determine if the borrower’s debt-to-income ratio leaves him or her with sufficient resources to repay the loan over the long term.
Hard money lenders base approval and interest rates on the characteristics of the property. The lender considers the location of the property and often offers lower interest rates for properties in good locations. Properties in poor and remote locations are considered higher risk, so hard money lenders require more interest to protect themselves from a potential loss. Properties in good locations are easier to sell if the lender repossesses the property. The borrower is also more likely to succeed in selling or refinancing the property instead of defaulting.
Hard money loans are called fast money loans for a reason. Hard money lenders take very little time in approving loans, making them a great resource for borrowers that need a loan in a hurry. Because hard money lenders base their decisions almost exclusively on the property value and LTV ratio, their approval processes are straightforward. The lender can quickly analyze comparable home values in the area to determine a value. Sometimes the lender does a “drive by” appraisal, to confirm that the property remains in reasonable condition. If the lender can see that the LTV is in line, it will generally approve the loan.
This streamlined process works great for borrowers in foreclosure who need to preserve the equity in their homes. Their credit problems make no difference in obtaining a hard money loan, so they can use it to get out of foreclosure and preserve the equity they have built up in the property. The borrower can then sell the property and keep the remaining equity or refinance the hard money loan into a conventional loan with a lower interest rate.
Hard money loans are short-term loans designed to provide a bridge. This bridge allows the borrower to get past the situation causing them to need the hard money loan. Most hard money loan terms are one or two years, after which the borrower resells the property or refinances. For borrowers at risk of losing property, a hard money loan can make the difference that saves their hard-earned equity.