One of the advantages of hard money loans is that the private money lenders who underwrite them are not bound by the same rigid federal restrictions that govern banks and other institutional lenders. This series of blogs will explore the types of out-of-the-box loans in which private capital lenders specialize and highlight how hard money loans can be a crucial tool for the savvy commercial real estate investor. There are eight common types of loans that private capital lenders will underwrite when banks typically will not. These types of loans  will be explored in detail over eight blogs: Cash-Out Bridge Loans, Loans to Foreign Nationals, Marijuana-Tenanted Properties, Note-Purchase Loans, Non-Recourse Loans, Vacant Land Loans, Tight Timeframe Lending, and Beyond the Typical Requirements.

There are three types of loans that typically do not fit within the typical box for bank loans.  These include insufficient debt service coverage (DSC) loans, insufficient global income loans, and profitability trending downward loans. Private capital lenders are able to finance loans such as these that are often rejected by bank lenders because a hard money lender’s underwriting process is asset-based, focusing on the value of the particular property that the loan is for rather than the rest of the borrower’s real estate or investment portfolio.

What Are Insufficient Debt Service Coverage Loans?

One of the metrics that bank lenders use when assessing loan applications, especially for commercial properties, is what is known as the debt service coverage (DSC) ratio, which is a ratio of available cash to loan payments (including interest and principal amounts). Banks usually require a certain percentage of DSC to approve an application for a commercial mortgage. For example, if the monthly payment on a bank loan is $1,000 then the bank will require proof that the property has net earnings (after all expenses of at least $1,400 per month.  This is known as a 1.4 x DSC ratio. Banks in all cases require a DSC ratio of at least 1.2 and sometimes higher than this. Hard money lenders will not always approve loans for borrowers with low DSC, but  in certain circumstances, they will build an interest reserve into the loan principal that  then can be used to make the required interest-only payments for the term of the loan. In this way, the hard money loan grants the borrower time to stabilize an under-performing property until it is profitable again, has a sufficient DSCZ ratio to an be refinanced with long-term, lower-interest traditional mortgage from a bank or life insurance company.

What Are Insufficient Global Income Loans?

Federal regulations require that banks consider a borrower’s global income.  Global income means reviewing all sources of income for the borrower.  If the borrower wants a loan on just one of (say) the 6 properties they own, then the bank must review in detail the income and expense of all 6 properties, not just the property that will secure the loan. This long and difficult bank review process often result in borrowers with good credit histories and good credit scores having commercial loan applications rejected for insufficient global liquidity. Private money lenders differ from banks in this instance because they are not required by the federal government to take a borrower’s global income into consideration. The asset-based underwriting process, basically just using common sense, means they normally only review the specific property that is the collateral for this specific loan.  This means that, as we have been discussing, hard money lenders can get the deal done when banks cannot.

What Are Profitability Trending Downward Loans?

If the borrower is a small business rather than an individual, then bank lenders rarely approve a loan that is for a business with decreasing profits. As with individual borrowers, private capital lenders are interested in more than just numbers and will consider the circumstances and explanations surrounding any lack of profit before making a decision about financing the hard money loan. For this reason, it is possible for businesses with downward-trending profits to acquire short-term hard money loans.

Underwriting loans that don’t fit the typical institutional lender requirements is just one example of the flexibility and willingness of private capital lenders to work with their borrowers to find creative, speedy lending solutions to time-sensitive financing problems when conventional lenders often just say no. Check out the other blogs in this series for other examples of how hard money loans can work for you.

For more information about Montegra’s private capital loan programs, contact us at 303-377-4181 or loans@montegra.com.