Hard Money Lenders And Foreclosure

The New York Times has just published an interesting article on hard money lenders. These are private lenders that charge a higher rate of interest. I have seen clients accept such loans at rates ranging from 9 to 15%, with the idea being that they will refinance again a year later into a more conventional loan at a better rate. Usually it takes at least one year after foreclosure to become eligible for better loans.

Mortgages Turning to ‘Hard Money’ Lenders The New York Times
By BOB TEDESCHI
Published: August 3, 2007

IN decades past, borrowers who were turned away from traditional mortgage lenders turned to the private lending market, where wealthy individuals or small companies offered mortgages with much higher interest rates. Now, because of the subprime crisis, banks are again turning away borrowers with poor credit, and industry executives expect these borrowers will again turn to so-called “hard money” lenders. This time, though, borrowers will have more legal protection against unscrupulous lenders.

“Lenders aren’t as interested now in lending to some individuals because they’re going to have a harder time repaying,” said Hugh Bromma, the chief executive of the Entrust Group Inc., a financial advisory company in Reno, Nev., that helps clients lend money on the private market, among other things. “Those people will have to go to private lenders, where the standards are significantly different.”

Mr. Bromma and other industry executives said private lenders typically demand interest rates of at least 12 percent, and they will make loans only when the borrower has more than 30 percent equity in the house. Such borrowers may have large down payments from, say, a house sale or an inheritance, but they may have low credit scores.

Lenders can demand even higher interest rates and equity minimums depending on how much of a credit risk the borrower appears to be. That is because if the borrower defaults, the lender must follow a foreclosure process that can be very costly, especially in New York, Connecticut and New Jersey. (In other states like Texas, lenders can foreclose much more quickly and cheaply.) Application fees, too, are much higher.

Finding hard-money lenders can be difficult, since they are typically small operations that lend cash only for homes within a limited geographical range. Among other things, this helps them more fully understand the risks, and resale potential, of the homes. Some brokers will refer clients to hard-money lenders when conventional financing fails.

Hard-money lenders usually avoid states that have enacted tighter regulations. For example, in 2001 Connecticut passed the Abusive Home Loan Act that, like similar legislation in New York and New Jersey, goes beyond federal laws regulating lenders that make so-called “high cost” loans, or those with interest rates at least eight percentage points more than the Treasury note or bond with a maturity date closest to that of the prospective mortgage. (Last Tuesday, for instance, rates on the 30-year Treasury note stood at 4.75 percent, so 30-year mortgages with interest rates of 12.75 percent would be considered high-cost loans.)

Among other things, the Connecticut legislation also stipulates that lenders making such loans cannot charge prepayment penalties of more than 3 percent during the first year of the loan, 2 percent after the second year, 1 percent after the third and nothing beyond that. Closing fees cannot exceed $2,000 or 5 percent of the principal, whichever is higher.

Carmine Costa, the manager of the Connecticut Banking Department, said, “Almost all lenders have shied away from high-cost loans because of all the possible litigation and violations of various state statutes.” But some, he added, may lend money “just under” the eight-point threshold that triggers the regulations.

Frank Harrison, the managing director of Prime Asset Funding, a hard-money lender in Greenwich, Conn., said he had stopped making residential loans in recent years “because we got more worried about the litigious nature of these, and with more foreclosures in the market, there’s going to be more litigation.”

Mr. Harrison, who now lends money only for commercial real estate projects, said that even with stronger laws in place, borrowers seeking hard-money mortgages for homes should be on alert to abuse.

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