Hard money lending has gotten a bad rap over the years. Far too often, it is unfairly linked to predatory lending. Unfortunately, some people just assume that any form of lending that doesn’t go through a bank or credit union is either predatory, a scam, or both. Reality says otherwise.
Few would argue that there are predatory lenders out there. But predatory practices are not exclusive to certain types of lending. There are predators in the banking sector, in private lending, in the payday loan industry, etc. Singling out hard money as predatory is disingenuous.
The vast majority of hard money lenders are honest investors and business professionals looking to earn a good ROI. They do not want to be property owners and landlords. They do not want to be land developers. They are only looking to invest in worthwhile projects that will pay off for both themselves and their clients.
Funding Real Estate Deals
The myth of predatory hard money lending finds its roots in real estate deals. Simply put, the vast majority of hard money loans are made to help clients purchase property. According to Salt Lake City’s Actium Partners, some borrowers are looking to purchase commercial real estate they plan to rehab and rent. Others are developers planning to sell properties after redeveloping them.
Although Actium does not do house flipping deals, that industry is a big customer of hard money. Investors use hard money to purchase homes and renovate them before putting them back on the market. Hard money works well because it is available quickly and is usually more flexible than bank money.
The point of all of this is to say that hard money lenders have no interest in owning the properties their clients put up as collateral. Having to repossess a property as a result of default makes the lender a property owner who now must either maintain that property or dispose of it. Neither option maximizes ROI. Thus, it is not in the lender’s best interests to take collateral. This reality is the antithesis of predatory lending.
Higher Interest Rates
Hard money might also be considered predatory because interest rates are higher than what borrowers would get from banks. There is good reason for this. Hard money loans tend to be short-term loans, typically between 12 and 36 months. By contrast, a bank loan could go 5 to 10 years, or longer. Private lenders do not have as much time to make a decent ROI compared to banks.
But even at that, paying 10% over one year is still cheaper – in real terms – then paying 3% over 10 years. The client still pays less total interest because of the much shorter term. What is predatory about that?
Predatory Lending and the Law
Before a lender can be rightfully accused of predatory lending, its practices must be compared against the law. Unfortunately, there is no hard and fast definition of predatory lending that applies nationwide. Laws defining predatory lending vary by state.
The FDIC says that predatory lending occurs when loans involve one or more of the following three elements:
- Making unaffordable loans despite the borrower’s inability to repay
- Inducing a borrower to repeatedly refinance a loan in order to charge more interest
- Engaging in fraud or deception to hide the true nature of a loan product.
None of these three components benefit hard money lenders in any meaningful way. As such, genuine lenders have no incentive to practice predatory lending. They have every incentive to ensure they only make loans for projects that are likely to succeed.