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The "Ins and Outs" of Hard Money Mortgages

Navigating the world of hard money loans (private lending) is uncharted territory for most people - and it's not a "safe" environment like traditional mortgages. Along with the no-questions-asked financing comes some potential consequences for those who don't know what they're getting into. This article explains the process in detail...

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What's a "Hard Money" Mortgage?

Hard money mortgages are typically the vehicle of last resort, made to borrowers who are unable to get adequate financing from conventional lenders like banks, credit unions, and traditional mortgage companies. Hard money mortgages are offered by "B" lenders, they are either private investors and or private mortgage companies/syndicates.

For the most part when it comes to lending requirements and practices you will find them to be the most lenient and flexible about accepting risk much more so than your mainstream "A" lenders. Situations that will land you at the door steps of hard money lenders are, a poor credit rating and/or financial history, the acquisition or refinance of a property that doesn't fall within the categories or guidelines followed by mainstream lenders.

Other things like debt servicing guidelines, ability to prove income that are more strictly followed by traditional lenders are considerably more fluid with hard money lenders, there may also be a tight timeline that needs to be met, again the hard money lenders can act far more quickly than the mainstream lenders..

What are the Costs?

Of course all this flexibility in terms of approval guidelines for borrowers spells additional risk to these lenders, they offset this risk by charging much higher interest rates and fees than your mainstream lenders. There is really no set of rules that all hard money lenders adhere to they pretty much all do their own thing.

Having said that however, there are some average rates and fees you can expect to pay, for example you will find rates in the range of 8% to 16% and fees will vary between 2%-6% of the loan value. I know this sounds like a broad range but these things vary from deal to deal due to the very nature of the risk associated with that deal.

For example a first mortgage charge will normally carry a lower rate than a second mortgage charge, another deal that is requiring a higher loan to value will be priced higher than one with a lower loan to value. Basically deals are priced on risk, the higher the risk the higher the cost.

Another thing to be aware of is that hard money lenders do not do high ratio mortgages, in other words they generally like to see at least 25% equity in the property, therefore lending no more than up to 75% of its value. Now I have seen situations where some of them have even gone up to 85% but that's a one off, certainly not the rule. Most hard money lenders do interest only payments for the term of the mortgage thereby keeping the monthly payment costs lower than if it was a blended payment of principal and interest.

One final note because hard loans carry substantially higher interest rates they should only be used as a short term financing solution, and by short term I mean a term that ranges from 6-24 months.

Here are the two most important questions you need to ask yourself:

1) Can I make the payments? Make sure the answer is yes! Now many of you are thinking, who would be crazy enough to go into debt not knowing if they can or can’t afford to make the payments you would be surprised! In fact a fair amount of borrowers who get into trouble do so because they don’t have a monthly budget! That’s right, it’s not only this one payment you have to worry about, it’s all of the rest of your financial obligations.

Now there are hard money lenders out there who will add your payments into the overall mortgage provided there is enough equity. By doing so you won't have to worry about coming up with the monthly payments out of your pocket during the term of the mortgage. My caution to you here would be, only do this if by doing so you are improving your overall financial picture and exit strategy, and not simply buying time because you can't make the mortgage payments.

2) What's my exit strategy? It better by a clearly defined one. Now I know that you don’t want to pay the typical high interest rates that these loans come with forever, right? That’s why these loans should never be viewed as anything other than short term due to the interest rates, there should always be an exit strategy going in.

So what’s yours? What’s going to change during the term of this loan that’s ether going to allow you to pay it off completely or get it refinanced at normal rates? Is this hard money mortgage going to allow you to improve your credit score enough to take it out with conventional financing at the end of the term? Will you be able to fix up the property and sell it before the mortgage matures? Do you have some other investments, settlements and or inheritances etc coming in that will pay off this debt? Make sure that this financing will be able to stabilize and help your situation well enough so at the end you can pay it off and ride into the sunset!

Final Thoughts

If you find yourself in an overwhelming financial situation, such as a bankruptcy and or imminent foreclosure, medical illness, divorce, job loss etc and a hard money mortgage is the only way to avoid a financial catastrophe I want you to keep the following in mind. When you are under this type of stress and duress, you may be exposed to unscrupulous and predatory lending practices and schemes.

The vast majority of hard money lenders aren't the loan sharks and gangsters you see in Hollywood movies and they're not out there to gouge you, that's not to say that some of them won't given half a chance but most occupy a perfectly respectable and fill an important niche within the mortgage lending sector. If you want to improve your odds of meeting a professional do the following, shop around, don't be afraid to ask questions and do your homework. Hard money mortgages can either be a viable "Plan B" or one-way-ticket to financial disaster.

Know thy exit plan - and know it well...

About the Author:

Kam Brar is a licensed mortgage broker and has been directly involved in the lending industry over the past 10 years, bringing with him a wealth of knowledge and experience. His particular specialty throughout his career has been working with "challenge" customers, where it takes creative financing (and sometimes private loans) to accomplish their goals.

His role with ShangriLoan is that of a consultant and mortgage industry liaison.



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