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Borrowers Find "Hard-Money" Loans Appealing

MIAMI – Dec. 6, 2007 – Some mortgage seekers spurned by banks and other traditional lenders are turning to high-cost loans known as “hard-money mortgages.”

Once thought of as a last resort for strapped borrowers, these products – also called “private-money mortgages” – have different lending standards than traditional mortgages and carry substantially higher interest rates and fees. These days, however, they are attracting a larger, more-affluent group of consumers. No organization tracks statistics in this highly fragmented industry, and many loans are made by private investors who report to no one. But anecdotally, business is booming.

At Miami-based Yale Mortgage Corp., one of the industry’s larger players, loan applications so far this year are up as much as 30 percent from a year earlier, translating to between 50 and 75 additional submissions every day. At Alliance Portfolio, a much smaller hard-money lender in Aliso Viejo, Calif., submissions have jumped 50 percent to about 50 a month in the wake of the subprime crisis that erupted over the summer.

Seattle Funding Group, a Bellevue, Wash., firm that is one of the largest hard-money lenders on the West Coast, recently installed a new phone system in part to handle the calls now flooding in from consumers desperate to fund new-home purchases and cash-out refinancings.

“Now that subprime has basically disappeared, the hard-money lenders are pretty much the only source of capital for many people,” says Daniel Yeh, a mortgage-industry analyst at the Scotsman Guide, a trade publication based in Bothell, Wash.

Hard-money lenders range from individuals and small groups of investors who operate independently to small firms like Alliance Portfolio that get their capital from individual investors who pool their cash in search of higher returns. Larger firms, such as Yale Mortgage, rely on bank credit to make loans. These lenders are easily found on the Internet, and mortgage brokers will often know where to find lenders locally.

The industry is lightly regulated, though depending on how a mortgage is structured, lenders can be subject to state and federal caps on interest rates. The Federal Trade Commission’s Web site (http://www.ftc.gov) has links to consumer publications that explain high-rate, high-fee loans – a category into which hard-money mortgages fall. The agency says it hasn’t received many consumer complaints about hard-money lenders.

Unlike a traditional mortgage, which is defined largely by credit scores and a borrower’s ability to repay, hard-money mortgages are based almost entirely on the value of the underlying asset. That means a borrower’s income and credit score aren’t nearly as important as they otherwise might be.

Hard-money lenders protect themselves by requiring that borrowers have substantial equity in their collateral – either their home, investment property or a business – of 30 percent to 40 percent or more. Moreover, interest rates are generally in the low teens, and fees can be as much as 5 percent of the loan’s value. By comparison, the rates on traditional 30-year fixed-rate mortgages now average around 6 percent, and fees generally top out at 3 percent.

Jim Perry, president and chief executive of Alliance Portfolio, says he recently lent $180,000 on a $355,000 house in Lake Elsinore, Calif., charging a rate of 12.25 percent plus a fee of 2.5 percent of the loan’s value.

The home-appraisal process is more intense, as well. Because hard-money lenders base their underwriting on the underlying collateral, they analyze property and the local market more intently than do traditional lenders. Their rationale: They want assurances that a home is worth a particular amount so that if they must foreclose, they know they will recoup their money by selling the property.

Many hard-money borrowers are people of means who have substantial equity in their home, investment properties and their own businesses, but because they fall into lower credit tiers, they are suddenly unattractive to the same lenders that earlier this year would have wooed them with subprime mortgages.

Some are seeking a construction loan to build a house that a bank won’t fund in the current market. Some need to close a real-estate deal quickly and don’t have time for banks to run their long list of checks. Others need a short-term bridge loan to deal with issues such as a divorce settlement or tax liens.

Jack Gaglio, who runs a small food business in Rancho Mirage, Calif., says he opted for a hard-money mortgage to pay off other loans on his house and business because “I’m self-employed and a lot of business things end up on your personal record,” making him less appealing to a traditional lender. He says he has tried banks several times, and “at the end of the day, it’s basically a ‘no’ from them.”

Mr. Gaglio says he called Alliance Portfolio “and talked for 15 minutes, and they sent out someone to appraise my house the next day.” The mortgage was funded within several days. The rate, in the 14 percent range, “is not terribly higher than I would get from a bank after they start looking at everything” on his credit history, he says.

John Odegard, president of Seattle Funding Group, says the typical client he is seeing these days is “an equity-rich borrower with pretty good credit who needs money to close on a property now.” Afterward, most borrowers spend time navigating the credit market to find long-term financing that is more affordable.

Hard-money lending has been around for decades but has been marginalized for residential borrowers in recent years. That is because the rise of credit scores, computerized lending systems and the ability of banks to bundle low-grade loans and sell them on Wall Street gave traditional lenders a way to offer mortgages to riskier consumers at interest rates lower than hard-money lenders charged.

The subprime crisis has changed all that. And because of the upheaval, Woody Kahn, principal at Yale Mortgage, says “there’s a void” for borrowers who don’t have pristine credit. The upshot is that hard-money lenders are seeing a better quality of customers come through the door.

Joffrey Long, president of the California Mortgage Association and president of Southwestern Mortgage, a Grenada Hills, Calif., hard-money lender, says his firm was looking at mortgages a year ago in which the borrower had 30 percent equity. Now, it is routinely seeing borrowers with equity of 60 percent or more who still can’t qualify for traditional bank financing because of credit or income issues.

Still, delinquency and foreclosure rates are high in the hard-money industry, according to many lenders. Mr. Kahn, at Yale Mortgage, says between 35 percent and 40 percent of customers at any given time are delinquent on their payments by more than 30 days. Between 10 percent and 15 percent slip into foreclosure. No national statistics are available.

“We’re quick to foreclose,” Mr. Kahn says. “By the 121st day (in delinquency), you’re in foreclosure.” That is a far more frequent occurrence these days for hard-money lenders. Because of financially strapped homeowners and the flagging home market, Yale Mortgage has take back about 85 properties in Florida, Georgia, Tennessee and Arizona. The company has never had more than 10 homes on its book at any one time.

Though hard-money mortgages can stretch to 30 years, borrowers tend to use them as a short-term tool. Most are paid off within two or three years as borrowers find lower-cost, traditional mortgages to replace the hard-money loan.

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