Have you ever applied for an auto loan or a mortgage? If so, you are likely familiar with the idea of jumping through hoops to get approved and funded. All those hoops are the direct result of the approval metrics banks and mortgage lenders are subject to. Things are different with hard money.
As a form of private lending, hard money lending is not subject to the same rules and regulations. Lenders have a lot more flexibility in everything from loan structure to customizing rates and terms. As you might expect, private lenders also have different approval metrics.
Lenders Set Their Own Policies
Hard money lenders can be individuals or groups of investors who choose to pool their money. They can even be structured as firms like Salt Lake City, Utah’s Actium Lending. The one thing they are not is a bank. Hard money lenders and banks are two separate entities.
Hard money lenders have a big advantage and that they are free to set their own policies, within reason. They are allowed to take as many risks as they choose as long as they treat borrowers fairly under the law. What does this mean to approval metrics? It means lenders like Actium Lending can establish whatever criteria they like.
Although there are no set rules, Actium says that most private lenders focus their attention on two things when making approval decisions:
1. Collateral Value
Hard-money borrowers are required to put up some sort of collateral as security on their loans. Real estate is the choice in nearly every case. Lenders look closely at the collateral to determine both its value and potential. If they like what they see, they can move on to the next consideration.
2. Borrower Exit Plan
Hard money loans are typically structured as interest-only loans, meaning that the borrower only pays interest until the very last payment. His final payment includes interest and the entire principal. As such, lenders want to see a reasonable exit plan. They want to know how borrowers are going to make their final payments when due. A reasonable exit plan makes a hard money loan easier to approve.
Approval Metrics for Traditional Lenders
Although traditional loans offer lower interest rates and longer terms compared to hard money, they also come with stricter approval metrics. The metrics are governed by federal and state laws put in place to protect lenders and borrowers alike. Many of the rules now in place did not exist prior to the 2007-2008 housing crash. We know how that turned out.
Regardless, stricter approval metrics require a lot more work on a lender’s part. Banks and mortgage lenders need to look at:
- Borrower income streams
- Credit score and history
- Debt-to-income ratios
- Down payments and their sources
Traditional lenders cannot leave any stone unturned in the quest to understand a borrower’s creditworthiness. That’s why they are constantly evaluating everything from a borrower’s paystubs to his tax records and bank statements.
Trust Deed Arrangements
Hard money lenders can take more risks because of the way their loans are structured. A hard money loan with property as the collateral is typically structured as a trust deed arrangement. Without getting into the details, such an arrangement makes resolving a default scenario extremely easy for a lender. By contrast, banks need to submit to a long foreclosure process that could take a year or more.
The approval metrics between private and traditional lenders are considerably different. It boils down to how the two types of lenders do business. By comparison, hard money lenders have a lot more freedom.
