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There are plenty of terms one could use to describe hard money lending. Whether it is a traditional hard money loan or a bridge loan for real estate, this form of funding is often described as ‘an option of last resort’. Lenders prefer more descriptive terms. After all, hard money is not an option of last resort for most borrowers. It is the best option for their circumstances.
Actium Partners, a Utah hard money firm based in Salt Lake City, prefers two distinct terms to describe what hard money is all about: asset-based and high equity. If you understand how these two terms apply to hard money and bridge loans, you probably understand exactly how this form of private funding works.
Asset-Based Lending
The place to start is the asset-based nature of the hard money model. Asset-based lending is based on a borrower’s assets rather than their credit history, income, and so forth. This is easily seen in the collateral borrowers must put up when applying for a loan. Consider a loan Actium Partners made a couple of years ago. The loan helped a client purchase a multi-unit apartment building.
The property itself acted as collateral on the loan. As such, the property was the asset Actium Partners was interested in. Actium team members did not have to look into the borrower’s credit history. They didn’t ask the borrower to furnish a profit-loss statement, monthly bank statements, and several years’ worth of tax records. They based their approval decision primarily on the value of the property itself.
Because the property acted as collateral on the loan, Actium was most concerned about its value in relation to the amount the borrower was requesting. That leads directly into the discussion of high equity.
High Equity Lending
Any piece of collateral is only as valuable as its potential sale price in relation to the amount being borrowed. Hard money lenders like Actium Partners apply loan-to-value (LTV) ratios in the same way residential mortgage lenders do. They will only lend a certain percentage of the total value of the property. This is where high equity comes into play.
Hard money lenders offer different LTVs, just as banks do. Let’s arbitrarily say a lender’s rate is 50%. The lender will only finance half the total purchase price. In addition, and appraisal of the property must demonstrate that it is at least as valuable as the loan amount. In most cases, hard money lenders are looking for more.
For example, say a client is hoping to purchase a piece of property for $500,000. The lender’s LTV is just 50%. That means the amount of equity – by way of a down payment – required is half the total sale price. The lender’s appraisal must demonstrate that the property is worth at least $250,000, if not more.
Skin In the Game
Being asset-based and high equity, hard money lending requires the borrower have substantial skin in the game. That is by design. Whether it is hard money or bridge loans for real estate, private lending of this nature is risky. Lenders do what they can to mitigate their risks while still supplying much needed funding. Among the many ways to do so is requiring borrowers to furnish valuable collateral with high equity.
Hard money isn’t the best option for every borrower or financial need. But when it is the most appropriate funding solution, it tends to work extremely well. That’s why firms like Actium Partners continue to do a robust business even when economic conditions aren’t as good as we would otherwise like them to be.