In the ever-evolving world of mortgage finance, lending rules constantly change for banks, credit unions, and other prime mortgage lenders, and life circumstances often change for borrowers. In recent years, many banks have slowed down their lending or tightened their underwriting rules such that sometimes borrowers discover that traditional real estate financing is not interested in them or their project. In these circumstances, a borrower may have success borrowing money from a private individual or organization offering private financing, where lending rules and guidelines are lot more flexible.
Private or ‘Hard Money’ Lending is simply a short-term loan secured by real estate. The terms are usually about 6 to 24 months, but can be longer. The loan payments could be interest-only or amortizing. As private lending is more expensive than traditional bank lending, a borrower typically wants to get in and out as fast as possible. At the end of the term, the loan needs to be re-paid, so knowing how you will make this happen (your “exit strategy”) needs to be very clear for both you and the lender (more on this later).
|Private rates:||6% - 18%|
|Down Payment:||20% - 50%|
|Payments:||Principal & interest, interest only, balloon|
|Additional Fees:||Lawyer, Appraisal, Broker, Lender, Insurance (Varies from deal to deal)|
|Qualification:||Income, Credit, Cash, Property, Exit Strategy|
Hard money loans are not appropriate for all deals. When purchasing or refinancing a primary residence with good credit, income history, and where there are no foreclosure or property condition issues, conventional financing through a bank is the best way to go. If, however, banks are not an option or the loan is needed in a short period of time, private lending may be the solution to help you bridge the gap. It is useful to think of a hard money loan as a means-to-an-end, perhaps a much bigger profit opportunity or to allow you to get back on your feet.
Typical lending situations:
Property Types: a borrower can get private lending on almost any type of property, including:
Some private lenders may specialize in one specific property type such as residential and not be able to do land loans, simply because they have no experience in this area. Most private lenders have a specific niche of loan they are most comfortable with. An experienced mortgage broker can help you quickly locate the correct lenders upfront, let you know type of loans they are willing and able to do, and under what terms.
Borrowers can access private lenders directly (Internet search) or through mortgage brokers. A mortgage broker experienced in private lending and with multiple lending sources will often know the better lenders and lending programs in the marketplace and if they can obtain for you a lower rate and better terms than you can on your own, you will instantly save money.
To qualify, lenders are primarily concerned with the amount of equity you have invested in the property. The more equity you have, the better terms you will be offered. Credit and employment are not so critical provided you can prove you have the resources to make the required payments and that you can present a plan on how you will ultimately repay the loan by the end of the term. This is called the “exit strategy,” which I referred to earlier.
Exit strategy examples (to repay the private lender)
I always say to my clients, we need to be able to convince the lender how you will be able to make your loan payments and that you will be able to repay the loan - "on a wing and a prayer" just won't cut it. The better you can articulate and document the specific steps you will take and timing to get there, the better your terms will be. Lenders will also need to see a current appraisal of the property (as-if-sold-today value) and their maximum loan will be based on that value.
Contact us and we'll be happy to hear you out and spell out some options.
In the next section (below), I talk about How Much Can You Borrow and Other Private Mortgage Questions
The distinction, terminology, and reasoning behind private mortgage lending can be confusing for consumers and other industry participants. Let's get you pointed in the right direction.
The amount of money a borrower can access is based primarily on the as-is value of the property to be financed, whether an existing property or one that you are about to buy. Location and property type are also important. Loan-to-Value (LTV) is a percentage of the loan to the value of the property. For example, a 65% LTV mortgage means the lender will advance as much as 65% of the appraised value of the property, and the borrower would need to provide the other 35%. The more equity or “skin-in-the-game” you have, the better your rate and terms will be. Available LTVs vary from lender to lender and from situation to situation, but generally 80% will be the maximum you could expect for a prime property.
It is important to understand how Lenders view and manage risk in a loan transaction. Their primary risk with any borrower is that the money will not be re-paid on time, or at all without legal action. Make no mistake (and with no disrespect), every mortgage lender, private or mainstream bank, must ask the following question:
When (not if) so and so fails to pay, how fast could we seize the property, how fast could we sell it, and will we get our money back?
Typically, the legal action for non-payment is a foreclosure and forced sale. After the sale is complete the proceeds are split: first the court is paid, then the foreclosure lawyer, then the Realtor is paid, then the mortgage lender(s), and finally any remaining amount or residual is returned to the borrower.
By limiting the maximum loan or LTV%, the lender is trying to make sure there is enough money left over to get repaid their principal and interest. Higher LTVs are available for more desirable properties that are likely easy and fast to sell. Lower LTVs are typical for properties which may be harder to sell fast. Higher LTVs are riskier for the lender in that there might not be enough left over to pay them in the event of default.
You can have more than one mortgage on a property, provided there is a lender willing to provide one. The mortgages are registered on your land title or deed in the order they occur which means that there is a pecking order in the event of borrower default. As the 1st position lender always gets fully paid out before the 2nd and so-on, there are greater risks for lenders expected to be in 2nd or 3rd position and interest rates will be higher in compensation.
There are higher risks associated with private lending for both the borrower and the lender. As such, the interest rates and costs can be considerably higher. A borrower needs to compare the total cost of financing against the benefits he or she will achieve.
Lending money is like most businesses: buy low, sell for more. It should come as no surprise that mortgage lenders intend to profit off your loan. Traditional bank lenders make their profits over time, perhaps a 25-year mortgage relationship, plus they make money on providing you with other banking services and fees. The supply of money comes from savings/chequing deposits and institutional investors, like pension funds. The difference between the interest rate the lender charges you and their cost of money is called the “spread.” From the spread, the lender pays their expenses and makes their profit. A typical bank spread is 1.8% per year, and a deal goes on for years.
Example gross profit for a $300K traditional bank mortgage for a 5-year term.
Private lending is similar in that the lender needs to make a profit/spread. Private lenders typically source and pool money from private investors, often doctors, dentists, and other professionals, and lend out that money to borrowers such as yourself. However, these loans are typically short-term in nature, perhaps 12-months, and often for much smaller loan amounts than bank lending. Even at an equal loan amount, the total interest collected from a borrower less the lender’s cost of money (the “spread”) is small relative to bank lending, but with equal effort to arrange and manage. To augment the spread and fund their lending operations, private lenders tack on a “lender/broker fee” as additional profit for arranging and supplying a short-term mortgage.
Example profit for a $300K private lender mortgage for a 1-year term.
As you can see in the example total gross profit illustrations, a private lender for similar effort on their part makes much less profit than a traditional mortgage lender, with the investors for private lenders, making the lion’s share of the interest paid.
In both lending examples, the borrower must pay any associated appraisal, inspection, and legal costs associated with purchasing the property and/or arranging the financing. The loan interest rate, repayment terms, and lender/broker fee are open to negotiation.
In Canada and most other jurisdictions, “predatory lending” (over charging) is illegal and in fact criminal, and the Fair Trading Act with full cost disclosure applies.
While some look at the cost of the loan, another view point is how the loan helps you achieve your objectives. This ties into your exit strategy.
For example, if come upon a property at a very attractive price, you are experienced at rehab/ renovations/ development, and you know what you could sell the property for after rehab (your exit), then a hard money loan might bridge the gap beautifully. To correctly analyze the opportunity, you would determine your purchase costs, selling costs, operating/hold costs, renovation costs and financing costs*, and then calculate your return on invested capital. You would need to convince the mortgage lender that you have the experience and cash resources to execute your development plan.
* an experienced mortgage broker can help you understand the analysis and to determine and access your least cost financing options
In this example, perhaps a loss of income (job loss, health issue, accident, etc.) has got you behind on your bills and your credit rating has been hit so hard, that traditional bank (“A”) lenders can no longer offer to refinance your existing property (you’re in the penalty box, so to speak). With your credit cards running at 19%-29% interest, you can see no way of ever catching up. Assuming you have some equity in your home, in this scenario you would borrow enough money to consolidate all your debts into a single lower payment 2nd mortgage and at a lower interest rate. With all your credit cards and bills paid off your credit score starts to recover. Soon it is sufficient to get out of the penalty box, and an A-lender will once again give you a mortgage sufficient to pay off the hard money mortgage and you are back on track.
In this example, a borrower – perhaps a senior - owns a property which is mortgage-free and desires to purchase a different property before her current one sells. Unfortunately, she has no cash to secure the new property until her current one sells – all her equity is trapped in the current home and her income is insufficient to qualify for a bank mortgage regardless. Her options are either to sell her current home first, and hope the perfect property comes up fast, or seek a private lender who will provide a short-term loan based on the equity in her current home. She uses the loan proceeds to pay cash for the next property, gets her current home on the market and sells it ASAP, thereby repaying the private lender in a few months. Note, even if she could qualify for a bank mortgage, her needs are very short-term, which are unprofitable for banks hence not typically available.
In this example, a self-employed client desires to build a home and needs construction financing. However, the borrower isn’t showing much personal income on his income tax returns and finds that traditional bank “A” lenders are not able to offer him construction financing based on “stated income” nor based on a significant down payment. While he cannot qualify for bank construction lending, the same bank lenders will offer him a self-employed mortgage once his project is 100% complete (a completion mortgage). In this situation, we use a private lender to fund the construction, and his “exit strategy” is a completion mortgage whereby the borrower secures a low rate bank mortgage and the private lender is repaid at funding. Nice soft landing.
In another scenario, the borrower can qualify for bank construction lending but does not have sufficient cash equity for the required down payment because her current home has yet to sell. A private lender might finance 100% of the new project by placing a mortgage on both the borrower’s current home AND the new property.
If you are considering a private mortgage as a potential lending solution, please contact us for a full evaluation of your options. The results might surprise you.
As licensed professional mortgage brokers, we know exactly what it takes to qualify you for a mortgage and we do more than just get you a great mortgage at a great rate, we will show you the way, too.