Hard money, or private lending, is gaining popularity as financing remains tight. But borrowers need to know exactly how it works before they sign for a loan.

Private hard money lenders are often the only alternative when banks and brokers are unwilling to lend. In today's economy, they are understandably in high demand.

Exactly what is a private hard money lender? It is a lender that does not use conventional standards to extend credit to borrowers. While banks and brokers evaluate credit history, income and debt to determine creditworthiness, private hard money lenders will often provide a short-term loan based on the underlying value of the property. Though they sometimes are difficult to find and their terms can be steep, private hard money lenders are often a good option when traditional financing is out of the question or when cash is needed quick.

Investors looking for foreclosure bargains and homeowners looking to buy some time are two groups increasingly pitching private hard money lenders.

Hard money for foreclosure investing

Recent studies reveal that more people are buying foreclosures investing than ever before, and many are using private hard money lenders to complete their purchases.

Jason Parker, operator of www.ShortSaleSuckerPunch.com, states, "Our clients oftentimes use short-term hard money to lock up hot deals that are too good to pass up. Then, they either partner up with another investor to refinance the deal or sell it to an end buyer, leaving plenty of profit on the table for everyone involved."

Parker says many of his buying strategies don't even require hard money, but knowing where to find it quickly is an added layer of security for investors.

Hard money to avoid foreclosure

Homeowners trying to avoid foreclosure may take on hard money financing to gain time to sell the property. If you have significant home equity, your goal is to sell your home in a way that pays off the lender and maximizes your proceeds. A foreclosure sale on the courthouse steps does not accomplish those goals. So you refinance with a hard-money lender (some offer very short terms and require no payments), market the property, and hopefully sell it before re-defaulting on the home loan. 

Finding hard money lenders

 Private or hard money lenders can be found in multiple sources including local real estate investment clubs, mortgage broker contacts, newspapers or online.

Peer-to-peer lending sites connect private investors who have money to lend with homebuyers who need special consideration--folks with plenty of assets and good credit but unverifiable income, for example. Other firms operate in a similar way, getting money from investors who decide which borrowers and projects they are comfortable with and what interest rate they will accept.

These days, though, even hard money is harder to get. Mike Sigala of Z Loan Investment in South Lake Tahoe, CA explains, "Things have become tighter all around. The loan-to-values are lower because you have to be able to attract investor money. (And) what's fallen completely off the table is hard money construction lending. It's perceived as riskier by investors as well as some lenders."

Pitfalls

Customers who can find a hard money lender shouldn't expect to be offered grade-A terms even if their credit is good--that's just not the private-lending business model. Private-money mortgages typically have rates in the double-digits and often come with several upfront points. Those who don't have at least 30% to 40% home equity or down payments probably won't even be able to get a loan. That's because hard money lenders limit borrowers' loan-to-value ratios so they can still make money from the properties if they have to foreclose.

Consumers need to watch out for "loan-to-own" predators, too. They structure hard money loans in such ways that borrowers inevitably fail, the lenders can take possession of the collateral properties and then profit from their sale. Carefully go through the terms of your loan and engage a real estate attorney if you don't understand them.
 

Costs

What does a typical hard money loan cost? That's difficult to say because there really is no "typical" transaction. But someone trying to avoid foreclosure might run into the following terms:

  • •Interest rates: 10% to 18%;
  • •Balloon payment: typical, usually due after one or two years;
  • •Maximum loan-to-value ratio: anywhere from 50% up to 70%;
  • •Points: four to eight.

Protection

Hard money lending can be wild and woolly, but for those purchasing one-to-four unit properties that they intend to occupy, there is another lending option. Fractional lending, in which groups of investors provide the money on these homes, is regulated by the federal government and, in many cases, state governments. Borrowers still get the protections afforded by Regulation-Z, the federal code which covers mortgage lending, and other laws in two significant ways.

First, there are added restrictions, such as limitations on prepayment penalties, negative amortization, default rates, and balloon payments. If the loan contains any prohibited terms, it is a violation and subject to an extended rescission, meaning you can cancel the loan.

Second, there are additional disclosures that must be provided to the borrower that are triggered by loan terms considered especially burdensome. These disclosures must be provided three days prior to signing, and if they are not, the loan is also subject to the extended right of rescission. There are also additional statutory penalties and, in some states, California included, the lender may be subject to punitive damages. Note: These restrictions don't apply if you borrow the entire amount from a private person or finance investor property.

This article was originally published on HSH.com.