It has been said that hard money lenders are equity-driven. They are also described as asset-based lenders in certain circles. Combine the two descriptions and you get a good idea of how hard many works. If this is all foreign to you, keep reading. This post will answer your questions.
As you read, bear in mind that hard money lenders are private lenders. They are organizations like Actium Partners, a Salt Lake City, UT firm specializing in hard money and bridge loans for commercial purposes. Actium Partners specializes in funding real estate transactions.
Equity in Property
You might be familiar with the term ‘equity’ in relation to your own home. If your home is worth more on the open market than the remaining balance on your mortgage, you are said to have equity. Let’s say your home is valued at $300,000. With an outstanding mortgage balance of just $200,000, you have $100,000 in equity.
How does this apply to hard money lending? Let’s say Actium Partners is approached by a real estate investor looking for a $500,000 loan to obtain a multi-unit apartment complex. Actium will appraise the property to determine its current market value. They want to see substantial equity before they approve the loan application.
Perhaps the property appraises for $1 million. Approving the loan would instantly mean $500,000 in equity. Provided Actium’s loan-to-value (LTV) ratio is above 50%, there is enough equity to justify approving the loan.
Hard Money Is Asset-Based
The cited example does a good job of explaining what asset-based lending is. For the record, hard money and bridge loans are asset-based. Conventional loans are not. This is one of the biggest differences between hard money and conventional lending.
As an asset-based lender, Actium Partners isn’t so much interested in a borrower’s credit score, income, and tax records. They are interested in the value of the asset being offered as collateral. Again, assume a real estate investor looking to obtain a new piece of property. That property is the asset Actium will look at as collateral.
The asset needs to be worth a certain amount of money compared to the amount the borrower wants to finance. If Actium’s appraisal determines the property is valuable enough to justify funding, the loan is likely to be approved.
How This Differs from Banks
Bank loans are considered conventional lending. They are neither equity-driven or asset-based. Yet there is one obvious exception to this rule: home equity loans. As a homeowner, you can take out a conventional bank or credit union loan based on your existing equity. This sort of thing is very difficult, if not impossible, in the commercial sector.
Conventional lenders are not driven by equity in their commercial lending because doing so presents too much of a risk for them. Their business model demands that they be a lot more conservative in the amount of risk they take on. Private lenders can assume more risk due to a different business model.
Likewise, conventional lending is not asset-based. That is why banks and credit unions require borrowers to verify income. It’s why they look at credit scores, tax records, profit and loss statements, and so on. Approved loans are offered on a borrower’s full faith and credit.
Unlike conventional loans, hard money loans are driven by equity and secured by assets. Hard money lenders zero-in on asset value in relation to the amount being borrowed. Doing business this way gives them more flexibility to service loans that banks and credit unions will normally not touch. In the end, it’s just a different way of approaching the same financial need.
