Funded
Not a broker
Rating on Google
From experience, we can tell you that the majority of hard money loans are almost instantly denied within the first few minutes of the pre-approval process.
Telling potential borrowers “NO” all day is not as fun as one might think, so we thought it might be educational to write about why we, and most other hard money lenders, say “NO” all day.
Oftentimes, novice investors are not well-versed in the hard money loan game and therefore don’t understand a typical lender's underwriting process, the necessary documentation when applying, or red flags that will trigger an instant denial.
So without further ado, here are five reasons why your hard money loan will probably never see the light of day.
1. Undesirable Property or Location
While large banks focus on a myriad of factors surrounding a borrower's ability to service a monthly mortgage payment, hard money lenders instead focus on the value and desirability of the collateral asset.
Since hard money loans are secured by real estate, most lenders find it important for the property to be located in a major stable real estate market, in decent condition and in a high-demand area in case things go sideways and lenders need to recoup their investment capital.
Rural properties in the middle of nowhere, raw land with no immediate income opportunity or ground-up construction projects, are considered high risk and often very difficult to borrow against.
Lenders not only want to protect their investors' capital but also want to see borrowers succeed. Putting the borrower in a position to fail will cause headaches down the line for both parties.
That's why you won't see lenders handing out millions of dollars like candy bars on Halloween.
If something goes wrong during the loan, the lender will have to recoup their investment by selling the property, which is why a desirable property in a great location is more likely to get funded.
2. The Property is Owner-Occupied
Almost all hard money lenders will not even consider lending on an owner-occupied property (Crescent Lenders included).
By law, hard money loans are intended for business purposes; once a loan is used for a primary residence, it becomes a consumer loan, which changes everything from a legal standpoint.
Owner-occupied properties are complicated and heavily regulated by the federal government.
To loan against a borrower’s primary residence, the lender must comply with various laws, such as:
- Dodd-Frank Act
- Ability-to-Repay (ATR) rules
- QM (Qualified Mortgage) standards
- Foreclosure protection rules
Not only are hard money lenders not set up to operate under this type of compliance, but consumer loans also require a different licensing setup.
Instead, hard money lenders focus on funding fix-and-flips, bridge loans, rehabs, investment properties, and business loans, where the loan structure remains within the framework of hard money and business-lending regulations.
3. Loan-to-Value Ratio (LTV) is Too High
An example of 70% LTV is a borrower who wants to purchase a $1 million home and will put down $300,000 of their own money as a down payment.
Beginner investors sometimes get carried away by asking lenders for 100% LTV, essentially asking the lender to fund the entire project, which virtually guarantees a denial.
For a lender, this is almost always an instant deal killer.
Lenders want borrowers to have “skin in the game,” meaning they want the borrower to carry some of the risk alongside them, so there are repercussions if things go south.
You see, when a lender gives you money, the loan is usually structured for a 12-month term.
Anything can happen in that time frame, for example, the entire real estate market could get turned upside down, or the borrower could run into other financial problems, forcing them to default on the loan.
There are endless potential negative situations that could arise with implications for the lender’s ability to recoup its initial investment.
This is why most lenders will only offer a maximum LTV of 65% to 75% of the property's value, helping to share the risk between the borrower and the lender in the event of market fluctuations, project delays, or borrower default.
4. Borrower’s Past Experience
A borrower’s past real estate experience is generally of great importance when they are doing a fix-and-flip project, so it’s not a necessity for all hard money loans.
Lenders want to see a proven track record because an inexperienced borrower increases the risk for a project to run over budget, take longer than expected, or fail to sell at the anticipated asking price.
Showing a lender that you’ve successfully completed similar projects in the past reassures them that you know what you’re doing and aren’t likely to screw up the deal.
Creating a relationship with a lender where you successfully execute time and time again will most likely result in you getting faster funding, better terms, and likely a lower interest rate.
Experienced borrowers give lenders confidence that the property will be renovated efficiently and sold for a profit, reducing the lender’s overall risk.
5. Unrealistic Exit Strategy
We can’t tell you how many potential borrowers call in each week who haven’t even considered an existing strategy.
Since a hard money loan is meant to be a short-duration loan, lenders need to know how you plan to repay them.
Without a viable exit strategy, lenders will be very hesitant to lend you any money.
If your plan to sell, refinance, or generate income from the property is unrealistic, poorly defined, or overly optimistic, the loan will likely not be approved.
Lenders always evaluate whether you can realistically repay the loan within the agreed timeframe.
A strong exit strategy clearly outlines how and when the property will generate the funds needed to repay the loan, reducing risk for both you and the lender.
Many smart, experienced real investors will even present 2 viable exit strategies, because they know it will increase the likelihood that their loan will be funded.
In Summary
Hard money loans are usually easier to qualify for than bank loans, but borrowers who grasp the lender’s perspective before applying significantly improve their odds of approval.
Knowing what metrics lenders value and what issues will cause them to deny a deal puts you in a different league than the average Joe inquiring about a hard money loan.
Hard money loans are more likely to be approved when the property is desirable and well-located, not owner-occupied, the loan-to-value ratio is reasonable, the borrower has relevant experience, and there is a realistic, well-defined exit strategy.
Be prepared, do your homework, have skin in the game, and you can be right on your way to closing some profitable deals.
Handpicked Resources
California Hard Money Guide Bridge Loans
Hard Money Mistakes
Commercial Hard Money Lenders Hard Money
How to Get a Hard Money Loan in California Hard Money
Why Choose a Local Los Angeles Lender Hard Money
Los Angeles Hard Money Loans
About the Author
Russell Barneson Hard Money Lending
Russell is a seasoned real estate investor, writer, and hard money lending strategist, as well as the co-founder of Crescent Lenders. He holds a degree from the University of Southern California’s Marshall School of Business. Outside of work, Russell enjoys surfing and spending time outdoors with his dog, Amy.