Private loan money is most often referred to as hard money, and usually the loan comes from a source that specializes in structuring such loans. More often than not a hard money loan will consist of a first mortgage on a residence thus creating hard money residential loans. There are a number of identifying factors involved in private loan money that will be referred to as a hard money loan.
For instance, as mentioned it is usually a first mortgage. Because the borrower’s credit does not matter as much as the amount of equity in the property, a first will in effect prevent a possible loss of the entire property if, for instance, another loan is “ahead” of the hard money loan. The reason why the borrower’s credit does not matter much for private loan money is that the lender looks to the property for its security, and the lender is also being paid dearly for the chance that the lender is taking by basing all the money on the property value alone.
You see, another facet of a hard moneylender is the fact that they usually charge very high interest rates as well as high points. At times, if the property is secure enough, those high points will be rolled into the actual loan. Often the loan is not paid in the typical Principle + Interest (PI) but more than likely is interest only with a balloon at the end of the stated loan period. In this manner, in effect, the borrower is paying interest on interest, since points are interest, and since the mortgage may have been calculated including the points, then every payment the borrower makes, paying interest only, is actually interest on interest.
Generally, most hard moneylenders want a careful appraisal of the property. This is again used as part of the protection that the private loan money lender desires. The lender will look at the Loan to Value Ratio (LTV), which is the percentage amount that the loan will be against the current value of the property. For instance a 70/30 LTV on a property appraised at $100,000 means that the lender would lend $70,000 against that property.
Taking this example further, let’s assume that the hard money residential loan on the property is $70,000 and the deal will bring the lender 5 points at a 12% interest rate, payable interest only. The loan is due and payable in its entirety in 2 years.
5 points is equal to $3,500. ($70,000 X.05), and at 12% a year, the lender would receive payments of ($70,000 X.12 = $8,400 per year divided by 12 months= $700 per month) $700 each month for two years. Remember that points are collected at closing when the loan is actually made. Thus in interest only the lender will make $3,500 + $8,400 + $8,400 = $29,300 in just two years. Perhaps you can see why individuals liked to make hard money residential loans!
However, with property values falling so quickly many hard money lenders took quite a beating. With a loss of approximately 40% of the value originally appraised for, the lender now must also go through foreclosure, which is going to cost the lender at least $8,000, plus eviction proceedings costing about $1,000, and they still must bear the costs of repairs on the house which the evicted owner may have completely trashed, as well as any unpaid taxes.
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