Hard money lenders are wealthy individuals and small investment companies that lend cash to borrowers who don't qualify for loans from traditional lenders. New legislation, which seeks to protect borrowers from abuse, may be scaring off lenders instead.
When Donna Summer was belting out her 1983 hit, "She Works Hard for the Money," she wasn't thinking about credit-challenged borrowers and the lenders who serve them. The disco diva's words are appropriate for the challenges of the hard money market, which affect parties on both sides of the transaction.
Hard money lenders have traditionally worked on the fringe of the mortgage industry, providing funds to borrowers who don't qualify for mortgages elsewhere. Several years ago, mainstream lenders began digging into this target customer base, offering subprime mortgages in all shapes and sizes to bad credit borrowers. But this trend has recently reversed itself. As more mainstream lenders exit the subprime mortgage arena due to rising foreclosures, hard money lenders are finding themselves in the driver's seat once again.
Compensating for risk
The terms of a hard money loan are aggressive. Interest rates generally start at 12 percent, while the minimum down payment requirement might be 30 percent. Hard money lenders recognize that credit-challenged borrowers have few options. These lenders aren't necessarily cruel at heart-they have to consider the probability of incurring foreclosure costs when pricing the loan. From the lender's perspective, the business of lending to known credit risks has to be profitable, or they wouldn't provide the service.
Some hard money lenders cut down on the risks involved by specializing in geographic areas and avoiding states with cumbersome lending regulations. Geographic specialization helps lenders maintain better insight into the current and future value of their customers' properties. Since these specialized lenders don't operate everywhere, some borrowers who need a hard money loan won't be able to find one.
High-cost loan regulations
Current lending regulations in some states present challenges for borrowers and lenders alike. The regulations are intended to protect bad credit borrowers from excessive rates and fees. While few would argue with the necessity for such regulations, they can prove to be too restrictive for some lenders. Connecticut, for example, specifies maximum prepayment penalties and closing costs on so-called high-cost loans. These are defined as those with interest rates in excess of eight percentage points higher than the Treasury note with a comparable maturity. Some hard money lenders are either avoiding the states with restrictive loan legislation, or are lending money at rates just below the high-cost loan levels. They do so to minimize their exposure to potentially expensive litigation.
The reality is that bad credit borrowers and their lenders both have to work hard for their money. Borrowers have to shop carefully, understanding that their options will be limited-and possibly expensive. Lenders must find a lawful middle ground between profitable and predatory lending.