Asset-Based Lending: How Is Hard Money All That Different?

A while back I was having a discussion with a friend about hard money lending for property investments. The topic of security came up. When I mentioned that hard money lenders almost always require investors to put up their properties as security, my friend couldn’t understand how that is any different than a bank putting a lien on a residential property.

Under both scenarios, the property in question could be on the hook if a borrower does not make his payments. A bank can foreclose on a property just like a hard money lender can. So at the end of the day, are there any real differences between the two types of lending?

Yes, there are. However, for the purposes of this post, I am going to focus on the asset portion of the question. There are fundamental differences in how the two types of lenders approach the asset that is property.

Hard Money Is Asset-Based

Hard money lending is frequently described as asset-based lending. Understanding what that means provides the foundation for this entire discussion. For a nutshell explanation, we turn to Actium Partners out of Salt Lake City, Utah.

Actium explains that in a hard money scenario, the property being acquired acts as collateral on the loan. A lender bases loan approval almost exclusively on the value of that asset. If the asset has enough value to cover the amount being requested, approval is likely. Otherwise, the loan will probably be denied. This is what makes hard money asset based.

On the other hand, conventional lenders do not base approval decisions on asset value. Yes, they do place liens on properties to protect themselves in the event of default. But approval decisions are based on a borrower’s ability to repay, not the value of the property being acquired.

A Completely Different Approval Process

Conventional lenders looking into a borrower’s ability to repay dictates a completely different approval process. Borrowers are expected to turn over tons of documentation so that lenders can look into everything from income to current debt load to credit history.

If you have ever purchased a home using a mortgage, you are familiar with the approval process. Conventional lenders leave no stone unturned. They are so thorough that even a loan presenting demonstrably low risk could be rejected simply due to a borrower’s credit score.

Hard money lenders go about it differently. They don’t look at credit history except for the possible reason of using it to help determine a borrower’s interest rate. They do not care about a borrower’s income, his history of making money on property investments, or even his current debt load. Their focus is the value of the property being acquired.

The end result is a quicker and more streamlined process. Hard money lenders don’t need a ton of documentation. They can make approval decisions in a matter of hours, under the right circumstances. And most of all, a good hard money lender can get from approval to funding in a matter of days.

Hard Money Comes at a Price

Hard money seems to have everything working in its favor from a borrower’s perspective. But there is one caveat: it comes at a price. Hard money loans are more risky than their conventional counterparts, so interest rates and fees tend to be higher.

Both hard money and conventional lenders may have to turn to foreclosure when borrowers default. But that is really the only similarity among them when it comes to the asset that is property. Beyond recovering losses, the two types of lenders look at assets in very different ways.