The following post was provided by Bills.com
At a recent party, I talked with a guy who brokers private mortgages. Naturally, my antenna went up and I peppered him with questions. Here’s what I learned in our conversation and research I did later online.
In the home loan world, what insiders call soft money loans get press attention because most consumers use soft money loans when buying houses or refinancing existing mortgages. Few know about private mortgages, also called hard money loans, because private mortgages are a specialty loan rarely sought by consumers.
I asked the broker why hard money loans exist, and who would be knuckleheaded enough to borrow money at a high interest rate when they can find a soft money loan at any bank or credit union for less. He seemed like a nice guy, but I thought of private mortgage loans as the homeowner equivalent of payday loans offered to the desperate seeking to avoid foreclosure.
Not so. People use private mortgage lenders for six scenarios.
Flipping: Ever wonder how people who buy properties, repair them, and sell them get funded so quickly so often? Private mortgages.
Raw Land Acquisition: Soft money lenders rarely loan money for raw land for many reasons, but the main one is it’s so difficult to appraise raw land with any degree of confidence. As one real estate put it to me, “In many cases, raw land is undeveloped for a reason. Banks would be crazy to lend on raw land.”
Construction Pay-Off: Oftentimes, home builders are intentionally not fully funded for spec home construction. A construction pay-off loan allows a home builder to finish construction on a home and prepare it for selling.
Standby Loan: Similar to a construction pay-off loan, these are loans builders must have lined-up for some construction projects, and may be needed when a project is completed.
Bridge Loan: Bridge loans are a catch-all name for short-term financing of real estate projects. One use might be a buyer seeking to take advantage of a fast-closing deal, such as the purchase of an under-valued property in a foreclosure auction.
Foreclosure Prevention: Used when an owner is caught between a buyer who cannot close immediately and a lender who is driving for an expedited foreclosure.
The common thread in all private mortgage loans are these four characteristics:
- Brief closing time (usually less than 30 days)
- Short term (6 months or so)
- High interest rate and closing costs
- Funded by a local private lender
Quick Tip: Think of soft money loans as long-range strategic tool, and hard money or private mortgage loans as short-term tactical tools.
Hard Money Lenders
The private mortgage broker said he earns a finders fee for matching borrowers with private mortgage lenders. I asked who these lenders are. He said the almost universal rule is they are local people. Most have a great deal of liquidity and the desire to earn more than what’s available from bonds and the stock market. A near-iron-clad rule in private mortgage lending is the lender looks at the property in person before making the loan.
Lenders do so to make an informal appraisal of the property in comparison to similar properties in the neighborhood.
Another rule most private lenders follow is to lend up to about 70 percent of a property’s available equity. Doing so limits the amount they may lose should the borrower default.
The broker said some brokers will specialize in certain types of deals. Some, for example, love the risk of flipping, and will work handshake deals with flippers with whom they’ve completed many deals. Others are more risk-averse and will focus on standby loans, which have fewer unknowns, generally speaking.
Private money lenders do not have storefronts or Web sites. They prefer to work with a known circle of brokers. Their only other form of overhead are lawyers who conduct basic title research on properties and draft loan contracts.