Colorado Real Estate Journal – Sept. 2007

The good real estate loans funded with private capital – sometimes called “hard-money loans” can be useful to the real estate investor in specific situations. Perhaps a borrower is simply not aware of the alternatives to bank financing; while others might associate hard-money loans with excessive interest rates and unethical practices. Listed below are some of the ways in which private capital loans may help the borrowers get the deal done when institutions are not able to do so.

Speed.

When a borrower finds his back to the wall because of time pressures, a private lender often can approve and fund a hard money loan more quickly than institutional lenders. Because private lenders rely on their own funds, they aren’t hampered by time-consuming loan committees and other institutional red tape. Private lenders normally can close loans within two to four weeks. When time is money, this fast response is obviously very valuable. Helping the borrower get his deal closed is the primary goal of the private lender.

Convenience.

Private lenders don’t require large and complex loan packages. Not only are these packages measured in inches, but also they often require personal financial information a borrower would rather not disclose. A private lender can take a loan application over the phone and frequently is able to give initial approval the same day. Borrowers talk directly with the decision-maker rather than a loan officer who is obligated to take the loan request through channels, which require many phone calls and create delays in getting the deal done.

Flexibility.

Institutions are burdened with rules imposed on them by regulatory agencies. Conventional lenders require a certain ratio of debt-service coverage; need a strong guarantor; and have to document a secondary source of repayment. Private lenders make their own rules! If the cash flow isn’t there, a private lender will build an interest reserve into the loan and/or ask for interest only payments. If there is no strong guarantor available, the loan can be made non-recourse. If credit isn’t up to snuff, the private lender will focus on the value of the property instead. This is asset-based underwriting, which forms the basis for private lending.

Reasonable pricing.

Private loans, naturally, are priced higher than bank or institutional loans. Still pricing can, and should, stay within reasonable bounds. Private money loans typically range from four to six points over prime usually fixed for at least one year, with loan fees in the two to three point range and maturity dates of between one and three years.

The Bad Loans

There are certain pitfalls of dealing with some private lenders that well-informed borrowers must take into account before making the decision to move forward with their loan applications.

Misrepresentation.

Some private lending sources represent themselves as principles in the initial interview. They claim that they will fund the loan themselves when in reality they are acting as in intermediary who can only attempt to place the loan elsewhere with the actual lender. This frequently results in unanticipated delays in getting a loan approved and /or funded. From the borrower’s perspective, this also may result in additional fees being charged to the borrower in order to compensate both the intermediary and the actual lender. This type of misrepresentation should not to be confused with working with legitimate borrowers’ brokers, who play a very valuable role in procuring loans for borrowers in unusual or complex situation. These professional loan brokers make their role and fees clear up front.

Exorbitant interest rates.

Another danger that prospective borrowers face – when they don’t realize that there are reasonable alternatives in the private lending arena – is agreeing to pay exorbitantly high interest rates and loans fees, which may ultimately jeopardize the property they’re trying to protect.

The Ugly Loans

It has become all too common to hear borrowers who have been victimized by brokers/lenders who take their money and run. This is a danger the prospective borrowers must be wary of and take steps to protect themselves against.

Upfront fees, but no loan.

Some brokers/lenders operating at the edge of legality will ask borrowers for substantial upfront fees in the thousands of dollars; then they keep the upfront money and fail to close the loan. Because these dubious private capital sources require prospective borrowers to sign complex and misleading agreements, often they are able to get away with these unethical practices. A borrowers needs to exercise due diligence to ensure that they are working with a reputable private lender. They should request references from a private lender and have an attorney review any documents and agreements before paying upfront money. Prospective borrowers must use extra caution in dealing with out-of-state firms that make promises that sound too good to be true. They almost always are!