If I had a dime for every time that I heard someone say that hard money loans are designed for people with bad credit, I would be a millionaire. Here’s the thing: it is not true. Hard money loans are widely misunderstood as bad credit loans. Yet they are anything but. In fact, a borrower’s credit barely plays into the loan equation.
Although hard money doesn’t deserve its reputation as a form of borrowing for people with bad credit, how the myth got started is understandable. It all boils down to the fact that hard money lenders typically do not look at credit histories and scores before making approval decisions. They also don’t go through the long and arduous process of verifying income, debt load ratios, etc.
The fact that hard money lenders don’t look at credit histories leads people to mistakenly believe that lenders are looking to loan to people with bad credit. But truth be told, nearly all hard money loans go toward real estate investments or business funding needs. The nature of how the loans are structured is such that lenders have no need to look into credit histories and scores.
When a bank or credit union begins processing a loan, they are compelled by both regulations and their own business models to verify the borrower’s creditworthiness. That’s why they pull credit reports and ask for proof of income. In a business setting, it’s why they ask for things like profit and loss statements.
Hard money lenders are different. Their business models are based on asset value. Imagine Salt Lake City’s Actium Partners being asked to fund a real estate acquisition in Utah. The most important thing to them is the value of the property in question. The borrower will offer that property as collateral; its value being central to the question of whether the loan is approved.
Down payments and loan-to-value (LTV) are important in hard money. Borrowers are expected to put down significant amounts of their own money while lenders themselves tend to offer lower LTVs compared to traditional lenders. The combination of a valuable asset, lower LTV, and higher borrower down payment are enough to get the deal done without looking into credit histories.
It is worth noting why so many real estate investors turn to hard money loans. It is pretty simple: banks do not like to get involved in real estate investments for the most part. There are exceptions to the rule, but banks and credit unions find real estate investments too risky for their liking.
Even an investor with stellar credit would have trouble procuring a traditional loan to fund his next investment. Traditional lenders just don’t want to get involved. Investors are left to utilize hard money and bridge loans to expand their portfolios. Companies like Actium Partners do not mind. Hard money for real estate is a lucrative business that makes them a lot of money.
None of what you read in this post should be construed to mean that hard money lenders never look at credit reports. Sometimes they do. Most of the time, credit information is used to determine interest rates and terms. It is rarely used to determine loan approval.
Despite what you might believe, hard money loans are not bad credit loans. That is a misunderstanding that is perpetuated by bloggers who write about hard money without knowing how it works. You can take that to the bank.