Conventional wisdom suggests avoiding hard money financing due to higher rates and shorter terms. As the thinking goes, higher rates in shorter terms create a less favorable financial situation for the borrower. However, not everyone agrees with conventional thinking.
The argument against hard money based on rates and terms has one fatal flaw: it applies traditional lending principles to scenarios that are vastly different. Think of it this way: financing a home with a mortgage differs significantly from funding a commercial property investment.
You are talking about two different types of properties. The properties are being obtained for distinctly different reasons. So applying traditional lending principles to a nontraditional scenario inevitably makes hard money look bad. I would contend that hard money is actually good when taken at face value.
Speed Is a Big Factor
Most hard money and bridge financing is dedicated to property investments. With that said, one of the things hard money critics tend to overlook is the importance of speed in the investment game. Commercial properties go fast when they represent good investments. And in many cases, sale price is not the deciding factor. Speed is. The buyer who can get to closing the fastest tends to win.
Investors are willing to pay a higher interest rate in order to get to closing quickly. Holding out for a lower interest rate does not help if it means the investor loses out on the deal. In such a case, nothing has been gained by insisting on a lower rate.
Underwriting Matters, Too
Hand-in-hand with funding speed is a simpler underwriting process. Simply put, hard money lenders tend to employ a very simple process that doesn’t require a lot of time and a ton of paperwork. By contrast, complicated bank underwriting processes generally mean that loans take months to arrange.
Actium Partners, a Utah hard money firm located in Salt Lake City, has been known to get from approval to closing in a matter of days. They once approved a hard money loan on a Friday afternoon and funded it Monday morning.
How do lenders get away with it? Hard money lending is private lending. Lenders are not obligated to look into every aspect of a borrower’s finances and credit. So they don’t. Hard money lenders make their decisions based on asset value. Actium Partners could get a loan application in the morning, then make a decision by late afternoon. All they really need is a positive appraisal that confirms the property’s value.
There Are Some Hidden Benefits
Believe it or not, there are some hidden benefits to higher rates in shorter terms. For starters, higher rates tend to weed out those investors who really cannot afford to take on any more debt. That is good for both lenders and other borrowers. But think about interest rates as they relate to terms.
Loan terms stipulate the amount of time a borrower needs to repay. A typical hard money loan has terms of 24 months or less. Every month of a loan’s term adds to the total amount of interest paid. So keeping terms short limits total interest. An investor will pay less total interest on a 24-month loan compared to a 360-month traditional loan, even if his interest rate is several percentage points higher.
The higher rates and shorter terms associated with hard money cause some financial experts to advise staying away from private lending. But that is only because they are applying conventional lending principles to scenarios that are anything but conventional. Hard money is actually a good deal when you understand how it’s utilized.