Hard Money Borrowers: You Need to Know the Difference!

The appraisal requirements of hard money lenders are one of the most important, but least understood, aspects of getting hard money, also known as private money or bridge loans. If you are thinking of using private capital financing, you must know how the lender is going to treat the appraisal of your property. Failure to understand this could put you at a great disadvantage in your efforts to get your loan funded in a way that works for you.

Fair Market Value Appraisals

Almost all traditional lenders (banks and life insurance companies) ask their appraisers for what is called a “market value” appraisal. Banks are required to follow the USPAP Standard for appraisals (USPAP is the abbreviation for “Uniform Standards of Professional Appraisal Practice).  

Under USPAP, fair market value is based on specific assumptions, including the following considerations

1. Buyer and seller are typically motivated; 
2. Both parties are well informed or well advised, and acting in what they consider their own best interests; and 
3. A reasonable time is allowed for exposure in the open market.

These assumptions reflect normal market conditions and are intended to produce a valuation that represents what a property should reasonably sell for in an orderly transaction.

Market Value

The term market value is often used more broadly and less precisely. While banks and other regulated lenders use the term to refer to fair market value as defined under USPAP, other lenders may use “market value” without clearly stating the assumptions behind it.

Without the USPAP framework, the term market value may reflect different conditions, such as shortened exposure time, limited buyer pools, current market trends, or other constraints that can materially impact the valuation. As a result, market value does not always mean fair market value unless the underlying assumptions are clearly defined.

Potential buyers should never assume that a reference to “market value” automatically means a USPAP-defined fair market value appraisal. In short, fair market value is the sale price a property would likely sell for under normal conditions with enough time on the market, while market value is a looser term that can change depending on how the sale is expected to happen.

Quick Sale Value

Many hard money lenders put on their website that they will go up to 65% (sometimes slightly higher) of “appraised value”. However, all too often, they do not mean the same thing by appraised value as a bank does. Instead, the hard money lender frequently means up to 65% of “quick sale value”.

Quick sale value means whatever the lender wants it to mean (unlike the banks, which must follow USPAP standards). Many hard money lenders want a value if the property is put on the market and must be “liquidated” in 90 days. There is no formal definition of “quick sale value”, but it is an estimate of what a property would sell for under an accelerated, time-limited sale. However, you can take it to the bank (pun intended) that quick sale value will be far lower than fair market value.

What Is a Quick Sale?

A quick sale refers to a property being sold under an accelerated and often distressed timeline, such as when the owner is experiencing financial hardship. In most cases, this means the property must be marketed and sold within a short period of time, often 60 to 90 days, rather than being exposed to the open market for a reasonable period. A quick sale assumes the seller has limited flexibility and may need to accept a lower price in order to complete the sale within the required timeframe.

Because of these time constraints, a quick sale does not reflect normal market conditions. As a result, prices achieved in a quick sale are typically lower than what the same property would sell for in a real estate transaction with adequate market exposure.

Valuation Example

Consider the following scenario.

A borrower owns a warehouse that has been appraised by a bank at a fair market value of $1,000,000, using a USPAP-compliant appraisal. The bank currently holds a first mortgage on the property with a balance of $650,000. For business reasons, the bank wants the mortgage balance paid off quickly, so the borrower turns to a hard money lender for refinancing.

The hard money lender advertises that it will lend up to 65% of the appraised value. However, the lender does not clarify that it bases its loans on quick sale value, not fair market value. The borrower proceeds and pays a $5,000 non-refundable upfront fee to cover underwriting and appraisal costs.

After the appraisal is completed, the borrower learns that the lender’s appraiser has determined the quick sale value of the property to be $500,000, based on an assumed 90-day liquidation timeline. At 65% loan-to-value, the maximum loan amount is now $325,000—far short of the $650,000 needed to pay off the bank loan.

At this point, the borrower is faced with two bad options: come up with an additional $150,000 in cash to pay the closing costs, or walk away from the deal, lose the $5,000 deposit, and risk damaging their relationship with the mortgage lender by failing to deliver the promised payoff.

This outcome surprises many borrowers, but it is a direct result of misunderstanding how the lender defines “value.” Because quick sale value is not governed by USPAP and is based on aggressive time constraints, it can be dramatically lower than fair market value.

Our Philosophy

Always use your own attorney to help negotiate your loan with a hard money lender. This is the very best way you can protect yourself – not using an attorney is penny-wise and pound-foolish.

Montegra, throughout its over 50-year history as a Colorado Hard Money Lender, has always used the “Fair Market Value” definition for its appraisals. We also insist that all of our larger loans require the Borrower to be represented by their own counsel. We do not require borrowers to have their own counsel. If they choose to use their own counsel, that is fine, but it is not required. We walk the walk. Be sure to verify that your hard money lender does the same.

If you are considering a Colorado hard money loan and want to work with a lender that uses fair market value appraisals and clear, consistent standards, contact Montegra to discuss your financing needs or apply online to get started.