There are many reasons why hard money loans can be useful to borrowers who want to purchase distressed properties, whether they are commercial or non-owner-occupied residential properties. Hard money loans allow purchasers to offer cash to the seller, which can provide leverage in price negotiations, and can usually be underwritten in weeks rather than months, which can help borrowers take advantage of quick turnaround deals. There are two other major benefits of using hard money rather than conventional loans to purchase distressed properties: how hard money lenders determine loan amounts, and how they can structure the loan to fit the deal. Brokers who know the benefits that hard money can bring to loans for distressed properties will be able to offer their borrowers more options and have a better chance of successfully securing them a loan.

How Hard Money Lenders Determine Loan-to-Value (LTV) Ratios Differently

Hard money lenders are known for offering lower LTV rates than conventional lenders; however, the way in which they calculate the LTV for distressed properties can actually result in a borrower receiving more funds from them than they would from a conventional lender. It is important for a broker to be able to recognize when this situation occurs to best help their borrowers take advantage of it.

As a rule, LTV rates are calculated to offer a certain percentage of a property’s value as the final loan amount. For example, if a lender offers a 70% LTV on a property valued at $500,000, then the loan amount will be $350,000. On the surface, if you just look at the LTV rates, it seems like a bank that is offering an 80% LTV loan is a better deal than a hard money lender who only offers a loan with a 65% LTV. This would be true if hard money lenders had to use the same standards to calculate their loan amounts as conventional lenders must; however, this is one instance where the lack of regulations over hard money can be a boon to the borrower.

Conventional lenders are required by Federal regulations to calculate their loan amounts using the lesser of either the purchase price or the current appraised value. This means that if a borrower comes to you with a really good deal on a distressed property that is valued at $500,000, but with a purchase price of only $400,000, then the 80% LTV bank loan will be based on the purchase price and the loan amount will be limited to $320,000. A direct comparison of this LTV rate with the 65% rate of a private lender would only be $260,000, which seems like a bad deal.

Hard money lenders are not bound by the same Federal regulations, though, and are free to choose the value that they want to use to determine the LTV for their loans. Most reputable private lenders will use the higher of the property values rather than the lower. Also, when dealing with distressed properties that the borrower plans to renovate, these lenders will often be willing to use the after-repairs value in lieu of the as-is value. This means that, revisiting the above example, if the lender uses the as-is value (rather than the purchase price as the bank did), the 65% LTV loan amount would actually be $325,000, which is just a hair more than the bank’s loan amount (but, perhaps, not enough more to offset the higher interest rate of the hard money loan); however, if the lender determines that the after-repairs value is $600,000, then the loan amount would increase to $390,000, which is only $10,000 less than the purchase price. This example is based on the lower end of typical hard money LTV ratios; there are many lenders who will offer up to 75% LTV ratios. Such an LTV would increase the loan amount in our example to $450,000, which not only covers the cost buying the property but also provides funds that many hard money lenders will let the borrower use to cover the rehabilitation costs or loan payments. This means that it is possible to actually get a larger loan amount from a hard money lender in spite of the lower LTV ratios.

How Hard Money Lenders Structure Loans to Fit Distressed Property Deals

As shown in the above example, it is possible in some situations for the available loan amount to exceed the purchase price of the property. When this is the case, hard money lenders will often be willing to roll additional funds (in excess of the property’s purchase price) into the initial loan amount for the borrower to use for rehabilitation costs or for the monthly interest-only payments during the loan term. This can be extremely beneficial for borrowers who have lower cash reserves by allowing them to keep some cash available for any issues that may arise unexpectedly during the property rehab.

To take advantage of this, borrowers should compile estimates of construction estimates and renovation costs to show how the additional funds will be used. This also helps to reassure the hard money lender that the borrower has the necessary experience and skill set to successfully rehab the property and repay the loan in full and on time.

Brokers should ensure that their borrowers are completely upfront with potential hard money lenders about any quirks or potential issues with the distressed property. Hard money lenders have flexibility that conventional lenders do not and, if they are told about potential problems ahead of time, it is likely that they will be able to structure the loan in a creative way that will address any such issues. However, if it seems that the problems are being covered up or hidden, then the lender may decide that they do not trust the broker or the borrower and end up rejecting the loan request because character is valued much more highly than credit scores.

How Hard Money Benefits Distressed Property Deals

There are many ways in which hard money loans can benefit distressed property deals. In addition to how lenders determine loan amounts differently from conventional lenders and the flexibility to structure loans to fit deals rather than forcing deals to fit inside a single loan-structure box, hard money loans can be obtained quickly (usually closing in weeks, if not days) to take advantage of deals requiring quick turnaround.

The actual loan amount for which a borrower qualifies will vary depending on myriad factors, including the amount of their down-payment, plans for the property, and the borrower’s character/experience with real estate investing. Reputable hard money lenders will be prepared to explain how they calculate LTV ratios for their loans and provide preliminary loan terms to brokers and prospective borrowers so that you and they can be sure of how the loan amount will be determined ahead of time.