There is an old cliché that a hard money lender makes loans in order to acquire properties at below market prices.  This is the “loan to own” concept.  There is no doubt that certain lenders at certain times may follow this strategy, however for the vast majority of hard money lenders this is nowhere near the truth. A look at the evolution of the name of these loans which have evolved from “hard money loans” to “soft money loans” to “private money or bridge” loans tells an interesting story.

In today’s financial climate, with banks severely handicapped by over-regulation from the Federal Reserve, the “shadow banking system” is slowly but surely taking over a great deal of the commercial real estate lending role that in the past was almost exclusively a bank or life insurance company province – shadow banking is a professionally managed pool of funds sourced from private sources that acts similar to banks in making commercial real estate loans.  Sources of private funds for these loans are derived from a wide variety of sources: hedge funds in New York, sovereign wealth funds from the middle-east, down to wealthy individuals using their own private funds or IRA money to fund loans to commercial real estate borrowers.

Hard Money Lending

The business model for the typical hard money lender is to fund a loan at above bank interest rates that is, however, a secure loan because of its conservative loan to value.  This is really how one would define a “hard money loan”.  The lender makes money from the up-front loan fees and then in many cases the loan is sold to an investor and the lender makes money from the serving of the loan.

Loan to Own

The “loan to own“ lender is hoping that by creating terms that can’t be met by the borrower, they can acquire the ownership of the real estate through foreclosure at a very favorable price.   There are problems with this business model.  After doing a certain number of these loans the lender is going to find a borrower who takes legal action against it and stands a chance of getting a significant award by demonstrating a pattern of predatory lending practices.  The country and its legal system are particularly sensitive to this type of lending after the melt down of loans in the great recession.  A foreclosure also does not always lead to getting title – there are other options for a borrower than losing the property and or other buyers may outbid the lender and end up in title which still leaving the original lender vulnerable to legal action by his borrower.

Predatory Lenders Shutting Their Doors

If proof of this theory is needed, take a look at how many hard money lenders (particularly in the residential lending arena) have closed their doors and are out of business.   Still – let the borrower beware is always a good motto.  A borrower who does their due diligence – checking with their local banker – their attorney – their CPA – and  commercial Realtors they know – as well as carefully researching the internet for derogatory comments on the lender and using social media like LinkedIn and others for research purposes as well.  Using a local lender from your area instead of some lender in a far off state found on the internet is another way to get maximum protection from falling into the clutches of a bad lender.  Research and common sense – don’t leave home without them.

[google_authorship], because of his more than 40 years of experience in funding hard money loans, is considered an authority on hard money or bridge financing.  He frequently speaks at meetings and conferences and writes articles on these subjects.