While much of what hard money lenders do differs substantially from traditional lending practices, there are a couple of things they have in common with their traditional counterparts. One of them is applying the loan-to-value (LTV) ratio to new loans. They do so for one basic reason: to require borrowers to put some skin into the game.
It’s true that hard money loans are easier to obtain than traditional bank loans. It is also true that hard money lending is asset-based. But lenders like Salt Lake City’s Actium Lending also utilize LTVs to protect themselves. Being a hard money lender doesn’t make Actium eager to lose money.
Down Payments Are Still Required
Hard money loans often go toward obtaining real estate. Sometimes they are utilized to expand a business, meet unexpected financial needs, or even provide temporary funding while an organization restructures its debt. But in nearly every case, borrowers are still required to come to the table with a down payment.
A typical Actium Lending scenario involves a real estate investor hoping to obtain a new piece of property. Actium isn’t going to fund the entire purchase. They put up some of the money, and the investor puts up the rest. What the investor puts up could be a combination of cash and additional financing.
The amount the investor puts up is heavily dependent on the lender’s LTV. Note that hard money lenders tend to offer LTVs that are quite a bit lower compared to traditional lenders. A 50% LTV is not unheard of. The other side of the coin is a 100% LTV. I don’t know of any hard money lenders that will foot the entire bill themselves.
It’s About Sharing Risk
The whole idea of requiring a borrower to put some skin in the game is rooted in the concept of sharing risk. Lenders don’t want to shoulder all the risk in any scenario. Even more so in hard money. Why? Because hard money loans are inherently risky from the start.
Let us go back to the fictional example of a real estate investor. There is no guarantee that the investor will make money on the property he hopes to acquire. There is no guarantee that the property will maintain its value a few years down the road. So any loan utilized to obtain the property is a risky loan.
A hard money lender doesn’t want to assume all the risk. It will not. The lender will require the borrower to assume some risk as well. With an LTV of 50%, the lender is requiring the borrower to take half the risk.
When the Risk Is Worth Taking
Given the risky nature of hard money lending, you might be wondering why a lender and borrower would be willing to take such risks. Quite frankly, they are often worth it. Let us start with the lender.
Hard money loans are short term loans – usually no longer than 36 months. This gives the lender an opportunity to get in and out quickly. This also means turning more loans, thereby increasing returns with each loan that reaches maturity. Lenders are willing to take the risk because the returns are so generous.
Borrowers are often willing to take the risk because hard money is faster, easier to acquire, and more flexible. Investors can do with hard money what they cannot do with traditional bank funds. And in an industry like real estate, where deals happen extremely quickly, there is a definite advantage to being funded by hard money, even though lower LTVs are the norm.
