If your impression of hard money lenders is that they make money through predatory lending practices, you are not alone. A lot of people think that despite the fact that it is not true. Predatory lending is not in a hard money lender’s best interest. Lenders make their money the good, old-fashioned way. It is legit and it works.
Hard money lenders have two primary means of making money: interest rates and origination fees. You may be familiar with origination fees as points on a conventional loan. Hard money lenders charge the same types of fees. Between interest rates and points, they are able to achieve a high enough return to make lending profitable.
Interest Rates and Short Terms
There is a lot about hard money that differentiates it from traditional lending. Right off the bat are the higher-than-average interest rates. Needless to say, borrowers pay higher rates for hard money compared to conventional financing. But there is an upside to this.
That upside is found in shorter terms. Where conventional loans can have terms ranging from 5 to 30 years, a typical hard money loan is for 12 months or less. So even with higher interest rates, it is entirely possible that a lender will pay less in real dollars on a hard money loan.
What many people do not realize is how big a role loan term plays in the cost of borrowing. Let’s say a property investor wants to borrow $500,000 from a hard money lender at 10% for nine months. His total interest payments would amount to $50,000. Now take that same amount and stretch it over five years at 5%. Total interest payments would work out to just over $66,000.
Interest Rates and Risk
Actium Partners, a Salt Lake City hard money lending firm, says that their industry is all about risk. Hard money lenders have to manage their risk while still making a profit. Higher interest rates and shorter terms are utilized for that very reason.
Actium’s hard money loans are made based almost exclusively on the value of the collateral being offered by the borrower. Because Actium doesn’t go to great lengths to dig into every detail of a borrower’s financial history, there is a heightened risk involved. But again, a higher interest rate and a shorter-term mitigates the risk.
Charging Origination Fees
As for the origination fees, they are pretty typical across all types of lending. Origination fees are charged to cover the administrative costs of making a loan. For example, consider a hard money lender being asked to fund the acquisition of a multi-unit apartment complex. Right off the bat, the lender has to value the property. That requires time and labor, both of which the lender has to pay for.
Should the loan be approved, it takes time and effort to draw up the paperwork. The lender must also work with a title company and others to get the deal done. Closing has to be conducted as well. All this costs time, effort, and money. Origination fees cover the financial costs.
Origination fees are generally calculated as a percentage of the loan amount. So 2% on $500,000 would be $10,000. That amount would be paid in addition to the interest.
And now you know how hard money lenders make their money. The truth is that they do not intentionally look to lend to risky clients just so they can foreclose on them. They make their money like any other lender does: by charging interest and origination fees. As they say, you can take that to the bank.