Hard money loans can save the day when traditional lenders do not want to help. Lenders are typically willing to take more risks in the hard money space, meaning they will often make loans that banks will not touch. But that doesn’t mean a hard money loan is always the best option. Even when it is readily available, there are times when hard money should be avoided.
Being private lenders, hard money lenders are able to take greater risks. They can lend to customers who would have a challenging time being approved by a retail bank. But with the additional risk comes a less lenient approach. Borrowers cannot afford to find themselves behind in their payments.
A Classic Case Out of California
A classic case proving the point comes out of California. It involves a man who, according to the San Francisco Gate, inherited a nice home in a local suburb some years ago. The man needed to arrange financing to rehab the home before he could move in. Unfortunately, the pandemic hit just about the same time he took possession of the home.
His employment situation and the ongoing pandemic dashed his hopes of securing traditional financing. So instead, he turned to a hard money loan. The loan was structured as an interest-only loan with a balloon payment at its 36-month maturity.
As you might imagine, the man’s financial position did not improve quickly enough as he approached loan maturity. He ultimately had to get a reverse mortgage to pay off the hard money loan he knew was coming due.
Not the Best Choice
Hard money loans are fantastic tools for funding all sorts of projects. They are most often utilized by real estate investors adding properties to their portfolios, according to Salt Lake City’s Actium Partners. Actium says it is not that common for a hard money lender to approve a rehab loan on a primary residence.
In hindsight, hard money was not the best choice for this particular project. It was an especially risky choice to make in light of the COVID pandemic and its subsequent impact on the borrower’s employment. Had he simply delayed rehab, he might have found himself in a better position than having to settle for a reverse mortgage.
An Exit Plan Is Critical
There is not much more to be said about the California case given the lack of details. But the fact that the homeowner had to turn to a reverse mortgage to pay off his hard money loan does suggest that he didn’t have a solid exit plan in place when he first applied for the loan. According to Actium, this is a big no-no.
Hard money lenders usually require reasonable exit plans before approval. Why that didn’t happen in this case is unknown. A more reliable exit plan may have made it possible to pay off the loan without having to look at a reverse mortgage.
In a commercial real estate setting, a hard money lender would definitely not budge without a good exit plan. The lender would expect the borrower to have some other access to financing, or even cash if possible, so that the balloon payment could be made on time. Even the slightest hint suggesting the borrower might not make the deadline would be enough to frighten a lender away.
It is fortunate that things ultimately worked out for the California man profiled by the San Francisco Gate. Things could have been much worse. As for the rest of us, the lesson to learn here is that hard money is not necessarily smart money, even when it is readily available.
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