The COVID-19 pandemic has created numerous challenges for all businesses, including hard money lenders. Lenders have been forced to adjust operating procedures to accommodate social-distancing requirements. This has meant that in-person client meetings were discouraged, if not forbidden, in some states.
While many employees were able to work from home, business shutdowns and uncertainty in the capital markets led to reductions in the workforce. Lenders began to take a harder look at debt-service-coverage ratios, borrower credit scores, loan-to-value ratios and payment reserves during the loan term.
When the real estate industry took a pause in the late spring and summer months of 2020, many private lenders reevaluated their underwriting guidelines and loan closing procedures. Until the market stabilizes, lenders offering terms of one year or more for fix-and-flip loans may consider offering shorter loan periods and/or require payment reserves.
Prior to COVID-19, many hard money lenders appeared comfortable with covering up to 80% of the as-is value of the asset being acquired, with some lenders going as high as 90% for seasoned, repeat borrowers. After the onset of the pandemic, however, these numbers (through an informal survey of lenders) decreased to 60% to 65%. As of this past November, they had returned to the range of 70% to 75%.
Renovation costs can still be covered up to 100% and paid to the borrower in draws during the rehabilitation process. Some lenders have taken a more conservative approach and have reduced loan-to-cost levels to 80% versus the previously available 90% threshold.
Mortgage originators should prepare their clients to understand that hard money lenders will likely tighten borrowing requirements, including asking for a higher downpayment. Additionally, lenders may require payment reserves to be held in escrow, so borrowers should have additional cash on hand to ensure completion of the renovation project.
It is quite possible that the U.S. could face another surge in foreclosures this year. The federal moratorium on foreclosures for home loans guaranteed by the government-sponsored enterprises was scheduled to expire at the end of 2020.
Anywhere from 225,000 to 500,000 homeowners across the nation were facing possible foreclosure through 2021, according to a July 2020 report from Attom Data Solutions. This could lead to an increase in distressed properties dumped on the market if Congress fails to take additional action to forestall this potential dilemma. With that said, many industry experts predict there will be nothing close to the foreclosure numbers seen after the 2008 mortgage crisis.
Naturally, an increase in distressed loans and foreclosures will create new opportunities for investors. For nontraditional lenders, this translates into an increase in borrowers seeking hard money loans to buy and rehab these investment properties, either to flip them or hold them long term for passive income.
The good news for investors is that there appears to be rising liquidity in the mortgage industry as the volume of lenders reentering this space has increased. Those with money to lend recognize that having a lien on the property provides solid collateral. Even better news for borrowers is that this added influx of lenders have begun to compress interest rates, as lenders have adjusted their loan programs to compete.
While private lenders of all experience levels have entered the hard money field, those with less experience have found their niche in the bridge loan space. These properties are typically stabilized without the need for renovation or remodeling.
Construction and fix-and-flip loans remain less competitive for established lenders because of their complexity. New-construction and renovation projects require a more knowledgeable lender that understands how to review the scope of a project, contractor bids and purchase contracts. Undoubtedly, lenders see potential growth in this area of business.
The pandemic has created another trend for city dwellers. Urbanites began looking to escape the confines of overcrowded cities and are moving toward the suburbs where there is more room for social distancing. This makes suburban rental properties an attractive opportunity for investors.
Hard money lenders typically focus on the fix-and-flip space to provide short-term loans for their clients. There are plenty of lenders, however, that are willing to offer attractive, long-term rental loans with rates, terms and fees that rival those of traditional banks, and with a far less rigorous underwriting process. Plus, an investor may opt to obtain a mortgage under their corporate name rather than give a personal guarantee.
Serious investors will benefit from the time savings and the hassle-free nature of acquiring long-term debt for their rentals from a hard money source that offers 30-year loans. Additionally, many lenders in this space that provide 30-year investment loans are doing so on a true 30-year basis in which the loan is amortized over the full term.
The longer amortization and payback period will positively impact cash flow, as well as keep the overall costs of debt service lower due to the lack of a need to refinance. Bear in mind, these rental loans often include a prepayment penalty window of three years, making them better suited for investors with long-term intentions.
The best way to locate a reputable lender is through word-of-mouth recommendations, commonly found at a real estate investor network meeting. Investors experienced in using hard money can provide advice and share possible pitfalls when securing a loan. Lenders also regularly attend these networking meetings, allowing prospective borrowers and brokers to discuss their needs directly.
Reputable lenders will share a track record of previous deals and positive reviews on their websites. When evaluating lenders, pay attention to their level of responsiveness and whether they offer personalized service.
A good lender will spend a reasonable amount of time determining the feasibility of the deal presented to them. The best lenders will want to participate in a transaction that is a strong deal for the borrower. The numbers should indicate that the project will meet the profitability targets of the investor, and therefore not put the lender or the investor at more risk than necessary.
Many borrowers utilize private lenders because they want to get a deal closed quickly. It is important, however, for originators to take time to compare multiple private lenders since the rates, terms, fees and borrower qualifications vary. Make sure it is an apples-to-apples comparison. Fix-and-flip and long-term rental loans have different criteria. For a fix-and-flip borrower, the fees for a six-month loan versus a 12-month loan might fluctuate by thousands of dollars, depending on the terms. Originators and their clients need to negotiate the deal upfront to solidify all details before closing.
The point is to focus on finding a fair and reputable capital source that offers excellent service and guidance, as well as the funds needed to operate an investment-property business. Chasing lenders to save a few hundred or even a few thousand dollars is counterproductive. If borrowers find a respectable lender that is intent on bringing them value at fair rates, terms and fees, they should stick to them like glue.
The numbers should indicate that the project will meet the profitability targets of the investor, and therefore not put the lender or the investor at more risk than necessary.
When evaluating a loan proposal, hard money lenders tend to base their assessments more heavily on an investor’s experience and the potential of the deal rather than a person’s credit. A minimum score of 620 to 650 is usually required, however. It may be helpful to prepare a property report on the asset that backs the loan.
Property photos, contractor bids for repairs, a purchase contract, proof of insurance and a preliminary title report will be required at some point during the transaction. The vast majority of lenders will require as-is value appraisals, and they will subject the borrower to a draw schedule for any loans that include rehab financing.
Borrowers will need cash on hand for the downpayment. Hard money lenders will not finance the entire amount of the project. Instead, they will calculate the loan-to-value ratio, typically between 65% and 80% of the as-is value or contract purchase price (whichever is less), to minimize risk.
Requiring borrowers to put their own money in the transaction serves several functions. It allows the lender to offer more attractive terms. It affords the lender a degree of comfort that the investor is serious and intent on completing the project, which will then deliver the funds needed to pay back the loan. Plus, it keeps the lender’s own risk ratios in line with their loan metrics.
Expect new opportunities and unknowns in the real estate investing world throughout 2021. As usual, however, the key for investor success will be to align with a competent mortgage professional who can be trusted to offer advice and guidance, then arrange the necessary resources. ●