Hard money lending differs from traditional financing in a number of ways. But there are other ways in which the two types of funding are quite similar. Take loan-to-value (LTV) ratios. They function nearly identically in both hard money and traditional lending.
A real estate investor hoping to get a hard money loan from Salt Lake City’s Actium Partners would have to be prepared to accept a lower LTV compared to a traditional lending institution. Whatever the LTV might be would dictate how much money the investor needs to bring to the table as a cash down payment.
The Basics of LTVs
The LTV principle is pretty basic regardless of whether you are talking hard money or traditional lending. To understand exactly what it all means, imagine you are hoping to buy a commercial office building. It has a certain market value in is current condition. That market value largely determines the asking price, what you offer, and the eventual sale price you and the seller agree on.
Let us say the agreed price is $8 million. Your hard many lender makes an offer with a 50% LTV. The lender is willing to offer you a loan equal to 50% of the sale price, which works out to $4 million. You need to put up the remaining $4 million.
Why Lenders Utilize LTVs
Lenders of all types rely on LTVs to protect themselves against excessive risk. Every time a lender makes a loan, it is risking its financial resources on a deal that could potentially go south. The combination of LTV and down payment requirements forces borrowers to put some skin in the game. This allows lenders to shift some of the risk to borrowers.
With this in mind, Actium Partners points out that LTVs often reflect the amount of risk involved in a deal. More risky deals call for lower LTVs. In the commercial real estate game, there is a lot of risk to be shared. That’s why hard money loans for real estate acquisitions carry some of the lowest LTVs in the lending industry.
It is not unusual for hard money lenders to go no higher than 50%. You will occasionally see an LTV of 60-75%, but such offers are rare. Moreover, it is nearly impossible to get anything higher than 75% on a hard money loan.
Properties Still Have to Be Assessed
One thing that does not change with hard money is the need to assess, or appraise if you will, a property before it is funded. In fact, assessing the value of a property is even more critical in hard money given the values you are talking about.
Residential mortgages are typically no more than a few hundred thousand dollars. That is a drop in the bucket in commercial real estate. Investors looking to buy lucrative properties are making offers in the millions. There is a lot more money in play on every single deal. As such, hard money lenders need to be satisfied that the properties they are funding are valuable enough to support the loans they offer.
A typical hard money lender either has its own on-staff appraisers or contracts with a local firm with which it has established a long-term relationship. Appraisals need to come back at, or higher than, the amount of money being borrowed in order for a loan to be approved.
So, there you have it. LTVs in hard money lending are remarkably similar to LTVs in the residential mortgage market. They are designed to protect lenders against excessive risk by passing some of that risk to borrowers.
