In some respects, bank loans are similar to hard money loans. They both require a willing lender who takes a security interest in collateral to fund the loan. Both loans must be repaid to release the security interest and retain ownership of the collateral property. However, in other respects, hard money loans are very different from mortgage loans, line of credit loans, or other bank loans. The reason is that hard money lenders look for a different relationship with borrowers than banks. Specifically, the best hard money lenders in Georgia are like business partners in your real estate deals.
Here are five ways hard money lenders differ from banks:
Debt to Income Ratio
The primary concern of banks is whether you are creditworthy. One metric banks use to determine creditworthiness is the debt-to-income ratio. Debt-to-income ratio is exactly what it sounds like. If you add up your debt payments for a particular time period and divide it by your income over the same period, you get your debt-to-income ratio. Excluding mortgages, the average American is carrying about $38,000 in debt. Qualified mortgages are only offered for borrowers with a debt-to-income ratio of 43% or lower. If your debt-to-income ratio is higher than 43% most banks will reject a loan application.
Hard money lenders, on the other hand, do not use a debt-to-income ratio to approve loans. Instead, they use a metric called the loan-to-value ratio. This takes you, your other debts, and your income out of the equation. This metric is based on the amount of the loan you are seeking and the value of the property you are using it to acquire. For example, if you need $100,000 to buy a piece of property that is worth $200,000, you can be approved for a hard money loan. This is true even if you are highly leveraged with debt because a hard money lender is solely concerned with whether your real estate investment is a good deal.
Low Credit Score
Another metric used by banks to determine whether to approve a traditional bank loan is your credit score. However, many people, often due to circumstances outside their control, have low credit scores. For example, as a result of the financial crisis of 2008, mortgage foreclosures peaked in 2009 and 2010 with 2.82 million foreclosures and 2.87 million foreclosures, respectively.
Many of these foreclosures were due to a bubble in home prices, onerous loan terms, and a sudden increase in interest rates that caused loan payments to skyrocket. In short, many of these loans were made in spite of borrowers’ knowledge that they would have trouble sustaining these loans on the grounds that borrowers could always flip the home before interest rates on variable rate loans locked in.
Few things affect a credit score more than a foreclosure on a several hundred thousand dollar mortgage. Consequently, a bank is unlikely to approve a loan application for borrowers with events like that affecting their credit scores.
Again, hard money lenders are not concerned with credit scores. Rather, they are concerned with the value of the real estate investment.
Insufficient Credit History
A new real estate investor is likely to have no credit history, no revenue, and no business assets. In other words, a new real estate investor is likely to have no chance at being approved for a traditional bank loan.
Banks use credit history to try to predict who is likely to repay a loan. However, new businesses and young borrowers simply have not had the time to establish a credit history. Hard money lenders, conversely, do not base approvals on credit history.
Because hard money lenders largely base their approvals on loan to value ratio, they typically do not need cosigners. To put it bluntly, banks often require cosigners on loans so that they have someone else to go after in the event of loan default. Since hard money lenders maintain a keen eye on the loan to value ratio, the collateral is often enough to satisfy the lender in the event of a default.
Hard money lenders operate differently than banks. Understanding these differences can help you decide whether you should consider hard money loans in Georgia for your business.