Would you lend to a borrower in foreclosure? Or someone looking to buy a large ranch whose value couldn’t accurately be determined with a standard appraisal? How about refinancing someone’s mortgage so the person can take out hundreds of thousands of dollars in cash?

For “hard money” lenders, it’s all in a day’s work. These private individuals and small local companies operate where even subprime lenders fear to tread, making loans to the desperate and needy the same way regular banks and brokers service traditional customers. They’re harder to find than mainstream lenders and they don’t come cheap. But they can help hard-luck borrowers make bad situations better — and sometimes, they’re a consumer’s only choice.

“There are private investors who, if the interest rate is high enough and the perceived risk is low enough, they will put the money up,” says Pam Strickland, owner of Mortgage Consulting Services in Santa Barbara, Calif.

Brokers and other intermediaries who arrange hard money — or private money — loans “go to people who have money to lend and they match them up with people who can’t get money any other way,” Strickland says.

Home buying the ‘hard’ way

If that sounds a little like how the Mob works, don’t worry. Hard money lenders aren’t loan sharks who break borrowers’ kneecaps when they can’t repay. At the same time, these lenders aren’t your Granny Sue. They charge interest rates and fees that would make conventional borrowers cringe and often base lending decisions on whether there will be enough equity in their subject homes that they can foreclose and still turn a profit. But private money fills a niche in mortgage lending, helping consumers who have specialized needs or too many credit problems to get conventional financing.

“It’s across the board,” says Brandon Thompson, a private money broker in Denver. “You’ll see anything from a $70,000 foreclosure to a half-a-million-dollar loan, where somebody just needs so much cash out and can’t verify their income to make it worthwhile for a traditional lender to look at.”

For instance, Strickland says one of her hard money lender friends recently did a construction loan for someone building a cabin near Yosemite National Park. Regular lenders balk at such deals because they don’t like financing properties in remote locations or those that aren’t of standard frame, concrete block or other traditional-type construction. Rural buyers sometimes use hard money loans, too. That’s because conventional lenders get antsy about mortgages for properties that derive a substantial portion of their value from the land rather than the house.

Buyers of expensive properties and those who already own such homes and want to cash out large amounts of their equity via refinance loans also turn to private money. So do real estate investors. These buyers purchase properties on the cheap, fix them up and sell them for profit. They use private loans because the loans come with less red tape and restrictions than bank loans.

Borrowers facing foreclosure make up the last major category of hard money customers. When someone misses a mortgage payment, that person usually has some leeway to bring the loan current. But once a 30-day delinquency turns into a 120-day or 180-day one, the lender will usually start the foreclosure process. At that point, the borrower is so far behind that even subprime lenders are reluctant to come in, refinance the loan and start the clock ticking again.

A hard money lender, on the other hand, may be willing to give that person a new loan. The customer can use it to pay off the original lender, gaining enough time to sell the property and find a new place to live. Borrowers who miss payments because of temporary problems, such as a job loss, can benefit, too. They can use the breathing room a hard money loan provides to rebuild their credit. By making payments on time for a year or two, they’ll lay the groundwork for a future refinance into a more favorable loan.

“These are temporary fix loans. That’s all they are — to help people get out of a bad situation,” says Kirk Johnson, a mortgage broker with Sierra Funding Corp. in Denver.

If you find one — be prepared to pay

That said, hard money borrowers face a steep hill to climb. For starters, hard money lenders can be difficult to find. Most operate only within limited geographical areas because they like to see the properties they’re lending against personally and know the area around them. Borrowers can try calling around to various mortgage brokers, some of whom have private investors who do hard money loans or know of people who do. Or, they can check their local newspaper’s classified advertisement section. Many papers have listings that read something like this: “Can’t get a loan? Call Us. Private Money Available.”

Customers who can find a hard money lender shouldn’t expect to be offered grade-A terms, though. Private money mortgages typically have rates well into the double-digits and often come with several upfront points. People who don’t own at least 30 percent or 40 percent of their homes probably won’t even be able to get a loan. That’s because hard money lenders limit borrowers’ loan-to-value ratios so they can still make money off their properties if they have to foreclose. Consumers need to watch out for “loan-to-own” predators, too. They structure hard money loans in such ways that borrowers inevitably fail just so they can take possession of their homes and profit off their sale.

“It’s kind of the same rules you get on any loan — clearly understand what it is you’re getting into. Understand what the fees are and what the actual cost of the money is to you,” Thompson says. “Be smart.”

Despite the pitfalls, lenders say that hard money loans can provide borrowers a lifeline in times of need. Consumers just need to make sure their loans will help get them out of debt, not bury them even further.

“If a property in a subdivision is worth $100,000, the loan-to-value on a hard money loan may be 50 percent to 65 percent, so maybe $65,000 maximum on a first mortgage is loaned against the property” to pay off the old lender who’s preparing to foreclose, says Robin Snyder, president of Mortgage Bankers Ltd. in Baltimore.

“That does not mean that that customer can’t take the property and sell it tomorrow for $100,000 and reap the benefits of that additional $35,000,” he adds. “A person is better off paying 14 percent, or a higher rate than the normal rate of 9 or 10, to keep the property rather than lose it. Or say you don’t get $100,000 for it, you get 90. Ninety is better than zero.”

‘Hard money’ loan costs and terms

What does a typical hard money loan cost? That’s hard to say because there really is no “typical” transaction. But someone trying to avoid foreclosure might run into the following terms:

  • Interest rates: 12 to 18 percent
  • Balloon payment: typical, usually due after 1 or 2 years
  • Loan position: must be a first mortgage, not second
  • Maximum loan-to-value ratio: anywhere from 50 percent on up to 70 percent
  • Points: 4 to 8

Assuming the worst rate and point structure possible, a $100,000 loan could cost as much $8,000 up front and $1,507 a month in principal and interest payments. Borrowers who don’t want to end up paying such steep prices should contact their lenders at the first sign of trouble making payments. They may be able to work something out and avoid foreclosure.

Sources: Kirk Johnson, mortgage broker, Sierra Funding Corp.; Robin Snyder, president, Mortgage Bankers, Ltd.; Brandon Thompson, private money broker.

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