There is no set of criteria that is standard or unique to the hard money lending universe. Most hard money lenders have a niche within which they operate (loan size, property location, property type, etc) and will only consider loans that fall within that niche. However, a general set of loan evaluation criteria follows:
Is the property in the lender’s target area or in an area the lender understands? Is it easy to evaluate the property because there are similar properties in the immediate area? Are there issues with respect to access, visibility, fire protection, utilities, etc. Would the lender be comfortable owning and managing a property in that location in the event the borrower defaults and the lender forecloses? Much of the time the lender’s assessment of the location is subjective based on past experience.
Being able to determine the current value of the property is, of course, vital. “Current” is the operative word when it comes to value today. What the property was worth two years ago or will be worth once the real estate market rebounds is of no import to a hard money lender today. What will the property sell for tomorrow is the question they are looking to answer. Assistance from appraisers and real estate brokers may be used to aid in determining value or confirming the the in-house opinion.
No hard money lender is equally comfortable with every type of real estate. Each has a bias based on past experience , the current real estate environment and/or advice from other industry professionals. That doesn’t mean they won’t make a loan on a property type with which they are less familiar. They will just be conservative when they do so – possibly more conservative than another lender who is more familiar with that type of real estate.
How quickly can the property be sold if need be? Would a quick sale achieve a price sufficient to retire the loan in full? How long would the property need to be on the market to maximize the value?
Are there hazardous materials on the property or indications that hazardous materials may be present? This is of particular concern when dealing with older properties or properties where former occupants were likely to have used hazardous materials. A Phase I Environment Site Assessment made need to be ordered to determine the extent of the issues.
Does the borrower have title clean to the property? Are there liens, easements, use restrictions or other title issues that the lender would find objectionable? All lenders will require a lender’s title policy be issued by a credit-worthy title insurance company effective on the closing date.
Does the property generate any income that will be used to service the loan. What is the certainty of that income during the loan term?
Even though hard money lenders focus on the collateral, many are taking a much harder look at the borrower since the real estate bubble burst. Borrowers who are weak financially can still get funded but the amount may less than could be obtained if their financial picture were better.
What is the borrower’s net worth in relation to the value of the property and the loan amount requested? Is the borrower too highly leveraged (too much debt relative to the value of his assets)?
How much of the borrowers net worth is in cash or investments that could be readily converted to cash? What is the liquidity in relation to the requested loan amount? If the borrower doesn’t have a consistent stream of income, are the cash reserves sufficient to comfortably service the loan?
Does the borrower have sufficient income, either from the property or from external sources, to comfortably service the loan? What is the certainty of that income?
What is the borrower’s credit score? Any prior loan defaults? Prior bankruptcy? If the credit history isn’t stellar, can the problems be explained to the lender’s satisfaction?
Real Estate Investment Experience
How much real estate experience does the borrower have? Does the borrower understand how to deal with unanticipated bumps in the road?
LTV (Loan to Value)
The LTV is probably the most critical of all the criteria. Since the hard money lender is looking to the property as the ultimate source of repayment, he wants a margin of safety and will loan only a percentage of the property value, typically 50-70%, depending on the lender. If the borrower is planning to use some or all of the loan proceeds to improve the property, the lender may consider the ARV (after repair value) in addition to the current value or purchase price.
Because of the uncertainty in today’s real estate market, most hard money lenders are not making second mortgages and will require that their loan be a lien in first position. The loan will be secured by deed of trust and recorded to securely establish that position.
Hard money lenders make short-term loans, typically 6 months to 2 years. Terms of longer duration may be possible or extension provisions inserted into the loan documents in certain situations.
The interest rate will vary according to the lender’s desired return on investment and on the rate being charged by competing hard money lenders making loans on similar properties.
How does the borrower plan to repay the loan? The hard money lender will want to clearly understand, and have confidence in, the exit strategy.
How well thought out is the repayment plan? What is the likelihood of the plan succeeding? What could occur to derail the plan?
When does the borrower anticipate repaying the loan? How confident is the lender that date can be met? Does the loan maturity date allow for hiccups in timing?
Does the borrower have a backup plan in case Plan A fails?