Apply for a hard money loan with any brokerage and you will discover that the firm places a lot of emphasis on collateral. They are not alone. Collateral is the bedrock of hard money lending. Lenders put a lot of stock in it because it influences their own financial security.
The basic principles of collateral apply equally in both bank and private lending. Beyond those basic principles, there is a bit more to collateral when you are talking hard money. Keep reading to learn everything you need to know about collateral in the hard money world.
What It Is
Let us start with defining exactly what collateral is. Collateral is an asset that acts as security for a loan. It can be just about any asset a lender is willing to accept. In a typical home-buying scenario, the home itself is the collateral. The mortgage lender places a lien on the property with the expectation of repossessing and selling it in the event of default.
Collateral for a hard money loan can be a lot more flexible. More often than not it is real property, but lenders can accept other assets as well. For example, a small business looking to open a second location across town could offer all of its equipment. It is up to the lender to determine suitability.
How Collateral is Valued
Collateral is valued a little bit differently in hard money lending according to Actium Partners, one of the top hard money lenders in Salt Lake City. Lenders have to look at multiple factors based on the type of collateral offered. So let’s say Actium Partners looks at a bridge loan for a real estate developer. The developer offers a piece of property he is trying to acquire as collateral.
The lender has to look at current value and purchase price. Then it has to look at the property’s potential value after it has been developed or renovated. If the developer is looking for money to cover both acquisition and renovations, the potential value of the property down the road has to be commensurate with the total amount borrowed.
Sale Potential is a Consideration
Collateral must also be considered in terms of its sale potential. In other words, the value of a particular property doesn’t mean a lot if the likelihood of selling it isn’t very high. The last thing hard money lenders want is to be stuck with properties they cannot sell. That takes us to the next point, by the way.
Lenders Don’t Want It
Hard money lenders require collateral as security on their loans. Truth be told, they do not actually want to own that collateral. They are in the business of making money by lending. They are not interested in being property developers, landlords, etc.
As such, the requirement for collateral is as much about weeding out unqualified borrowers as it is providing some measure of security to lenders. Hard money lenders are smart enough to know that buyers incapable of producing adequate collateral are not good risks. Collateral acts as a filter for those types of borrowers.
Lenders Have the Same Legal Rights
Finally, hard money lenders have the same legal rights in regard to collateral as mortgage lenders and banks. Default on a hard money loan and the lender has the legal right to repossess and sell the collateral. This is true whether you are talking about real estate, business equipment, or any other form of collateral.
If you’re in the market for hard money loan, remember that collateral is everything. Be sure to educate yourself about it and all its implications before you decide to pitch a loan proposal.
