Nichole Bennet’s story is common. Earlier this year, Nichole Bennet, a social worker, sought to sell her home in Antioch California, to reduce debt. When Bennett’s mortgage lender, Wells Fargo & Co, refused her because her credit was too low – it was 600 – Bennet turned to one of the alternative commercial money lenders in the area. In October 2015, Bennet got the almost US$40,000 she needed to pay down US$1,900 a month in car, personal-loan and credit-card payments. In return, the company, one of the 700 plus commercial hard money lenders that dot California’s towns and plains, held onto a piece of her property.
Background to California’s lending situation
2012 was the year when Californian banks tightened their requirements. In the years leading to the real estate crash, easy financing helped people buy homes they couldn’t afford and then borrow against their equity as property prices rose. Collapse in home values ripped through banks and helped trigger the recession. Formerly high-functioning banks in California such as CitiGroup were ousted from their positions and it took several years of ‘musical chairs’ before banks, credit unions, and other traditional lending institutions finally settled down. When they did, they changed direction.
Banks and their like mostly rejected subprime mortgages, reduced the percentage of cash borrowers that they would accept for refinancing and tightened their credit standards for home-equity lines of credit (HELOCs) requiring higher FICO scores and full documentation. Conventional lenders allow only the most credit-worthy to tap their home equity. Private lenders, on the other hand, allow more slippage and also considered people like Bennett -who for some reason or another have cracked credit history and background. Bennet’s FICO score, at 600, is scarcely low. Commercial hard money lenders, in general, tend to slip to the very bottom accepting borrowers who have the shoddiest of histories and scores. Their reason? They evaluate the property rather than the background or fiscal merits of the borrower.
Forward to commercial hard money lenders
People like Bennet who have no choice turn to unconventional lenders – more precisely, hard money lenders (otherwise known as ‘bridge’ or ‘private money lenders’) for their funds. For Bennett this was terrific: It gave her a way out of an otherwise untenable situation. She needed to repay her debts and wanted to sell her home. The particular hard money lender that she chose enabled her to do so. The disadvantages, as Sarah Edelman, director of housing policy at the Center for American Progress, points out are the harsher repayment terms that are often double those of conventional loans. Some consumers could end up with more expensive products since they have mortgage plus interest rates that extend to an approximate annual 15% comparable to rates on some credit cards or unsecured consumer debt. Commercial money lenders offer an appealing upfront lump sum of cash – with borrower paying a typical 2 upfront payments (sometimes more depending on loan type, amount, and duration) and money plus interest spread out over the interim. Terms can be scheduled to meet the borrower’s ability. The problems come at the end with the huge balloon repayment that, at the moment, an approximate 65% of borrowers in California default on repaying. In these cases, the private lender has no choice but to retain the property so that he could sell it in order to recoup a proportion of his loss.
For Bennett, the situation was perfect. She had the money to repay, lacked her local bank’s acceptance for a loan, needed one of the smaller-sized loans that these commercial hard money lenders offered, and organized her budget so that she could repay the funds piecemeal… Not everyone can be or is as lucky.
More on Commercial hard money lenders
If you’re considering following Bennet’s example, commercial bridge/ hard money lenders may be perfect for you in that they do accept credit scores that dip below 620. (Banks hesitate to accept scores that are less than 680). On the other hand, homeowners must have at least 25 per cent to 30 per cent equity in their houses. Although most private lenders, at one time, tended to completely overlook personal credit history (focusing instead on the collateral), federal regulations and events impel today’s private lenders to conduct some credit background and investigation into borrower’s experience and work performance. After all, they’re risking lending the money! This leads to some private lenders adjusting the cost of the home’s investment based on the owner and the property, taking a larger percentage of price appreciation from riskier customers. The greater the risk to lenders, the higher the price for borrower.
Each lender has his own loan limit. Some are capped at 1 years, 5 years, few at 10. Some also offer back-to-back loans. Aggressive competition in prime areas of California is also driving investors to come up with more creative solutions for people to leverage home equity. Some, for instance, discount the appraised home value of its customers to account for the risk and generate greater returns earlier. All In all, however, these commercial lenders are also attractive to consumers in other ways too. They operate with less oversight than banks and other traditional lenders, because they offer products that are structured as equity rather than debt. As a result, borrowers have to wade their way through far fewer forms. The process is far easier, and customer can find herself with money in hand in less than a week.
Lately, investors have been exercising more caution with their transactions partly as a result of increased government regulation and also because of escalating Californian home prices. The process is somewhat slower since hard money lenders have to lay out their calculations and support their deals. They also have to give their client a few days to reflect and to reprocess the system if he, or she, wants. But Bennett, the social worker, hit her commercial private lenders at a good time. In an interview to Heather Perlberg, Bloomberg reporter last week (December 21, 2015), she mentioned how her personal loan from Springleaf Financial Services and auto, credit card and payday-loan debt with interest rates as high as 110 percent were paid off. Even if her home skyrockets in value, the highest annual interest she’d have to pay back her hard money lender is 14.8 per cent.
Bennett told the reporter:
“You can pay them back before 10 years is up, so that’s my goal,” she said. “My plan is to pay them back way before that.”