If you want to buy property and are considering borrowing a hard money loan (otherwise called a HELOC), you are more protected than ever since consumer and federal laws have issued a slew of regulations in your favor. More so, consumer protection agency has just tightened its grip and sent out a survey to determine how to make the process even more secure.
What is a hard money loan?
Generally, borrowers who seek mortgages approach traditional lending intuitions such as banks and credit unions and are granted loans based on their FICO score and credit history. Those who are self-employed or who have spotty credit trustworthiness are almost certainly refused. Historically, and particular in California, banks are becoming more reluctant to lend to even legitimate investors. This is because housing prices have become exorbitant, fixing tends to become costly, and California government-based lenders have endured bad loans in recent years. For these reasons, shunned borrowers seek alternate sources, otherwise called unconventional funds (or lenders). One of these is the hard money or bridge lender who funds from his or her own pocket.
How does this work?
The lender looks at the value of the collateral rather than at your credit worthiness. If your property promises to be profitable, he risks handing you the necessary funds to fix or buy it. To offset the risk, the private, or hard money, lender – otherwise known as a ‘bridge lender’ – charges a hefty interest fee and huge prepayments (generally double the price of traditional loans). Historically, hard money lenders also provide low loan to value ratio (LTV) – namely disproportionately low value for your property; although, in larger cities of California this is beginning to change. If you default, the lender holds onto your property.
2015 has been a tough year for Californian residents. Housing prices have spiraled way out of control and most forecasts predict that 2016 will raise these prices higher still – particularly since the Fed intends to raise interest rates. Large numbers of borrowers have tripped short of payment. Real estate reports such as Redfin, a residential real estate company that provides web-based real estate database and brokerage services, say that 2016 will see even more borrowers siphon large amounts of money to private lenders, unable to repay in full and lose property as a result. (The borrower’s money is not refunded).
Borrowers are warned to be more careful than ever.
Here’s how you can protect yourself from lending scams
- Federal licensing – Consumer protection agencies and federal governments are working overtime to protect you. In California, lenders have to be specifically licensed by national and local agencies to practice. These include certifications from associations such as the National Mortgage Licensing System (NMLS). Exams are challenging and can take as long as it takes to pass. Any failure and broker has to retake until he or she is accepted.
- Law 6500 of Consumer Protection on balloon loans – Balloon loans allow borrowers to make incremental small payments until the loan has reached maturity whereupon the borrower has to make a substantial sum. This substantial sum can be – and usually is – frighteningly wallet-draining. These loans are risky if the borrower has minimized his income, is not disciplined enough for the final payment, or doesn’t understand its implications. To protect such consumers, FDIC created law 6500 on Consumer Protection which restricts balloon loans so that they cannot mature in less than 5 years. In some cases, such loans are even banned.
- Negative Amortization Bans – Negative amortizations refer to cases where the interest rates are so massive that the individual is unable to keep up with repayments. As a result, the borrower slides further into debt despite making repayments. The Government bans negative amortization.
- Government checks ability to pay – Too many borrowers find HELOCs (i.e. private hard money loans which rely on collateral) attractive since they imply that you can land funds even on low credit rating. As a result, many borrowers underestimate their ability to pay. Some private money lenders take advantage of this situation exploiting the borrower’s naiveté to pocket his property. To prevent this, federal laws on consumer protection insist that lenders must conduct some sort of credit check or income verification before issuing a loan. A lender who proceeds without checking the borrower’s financial ability, or, worse still, lends even though the borrower has a low chance of repaying performs, what consumer protection calls, a predatory loan. Consequences are such that the judge can render such a loan unlawful and dismiss it if it occurs. So if you got a “no credit check” hard money loan, you may be entitled to a complete dismissal of the debt under this regulation.
- Upfront payments – Hard money lenders tend to ask for relatively hefty upfront payments (think of double as much as the regular mortgage). This can include certain sums of interest and advance installment fees. Federal laws stipulate that the lender can ask for no more than two reasonable sized prepayments although the number and amount depends on the structure of the loan. If lender exceeds this, look into the regulation to determine if the request is lawful and reasonable. If not, you may be able to exit your loan contract at no penalty to you.
And the latest on consumer protection actions in California vis. Hard money lenders..
A few days ago (December 15, 2015), California Department of Business Oversight (DBO) launched an inquiry into the Marketplace Lending (P2P) industry. This P2P industry includes all private, non-government based lending individuals or organizations. Hard money lenders are one of these.
When last done in 2012, the DBO’s tentative steps to curtly restrain private lenders ruffled too many feathers. Consumers and business protested against government intervening in the private lending industry and predicted – needlessly as it happened – that restrictions would cripple housing market since borrowers and investors would be blocked from transacting. This time, DBO Commissioner Jan Lynn Owen hastened to assure lenders that the DBO does want the industry to grow but wants to “protect” consumers from fraud and exploitation. The DBO intends to tighten scope and conditions of its lessening structure so that fewer lenders -and only those more qualified and honest – will be able to practice.
So far, the DBO Surveyed 14 Marketplace Lending platforms in California requesting five-year trend data about their loan and investor programs. The results of the survey are still to come in.
What does this news mean to you?
This may be bad news for prospective agents and less qualified hard money lenders in California. More to pay and less to earn. But the DBO’s attempts to protect you are excellent news for you. Your chances of being defrauded by a private money lender will be less. If you decide to hire a private money lender, we hope that you will profit from your experience.