2 Reasons Why Collateral Could Prevent You from Getting Hard Money

collateral

Introduction

Hard money is considered asset-based lending. It gets its name from the fact that borrowers have to offer hard assets as collateral on the loans they obtain. In most cases, the asset is the piece of property being obtained with loan proceeds. Lenders take a good, hard look at properties in making their approval decisions.

Unfortunately, it is commonly misunderstood that any piece of collateral will do. This is not the case. Lenders look for very specific things in the collateral they accept. If they do not like what they see, they are likely to pass on a particular loan deal. On the other hand, a loan is pretty much guaranteed when a hard money lender sees an attractive piece of collateral being offered.

Below are two examples of collateral that could ultimately prevent a borrower from getting a hard money loan. They are compliments of Actium Partners, a Salt Lake City hard money lending firm that specializes in funding property investment deals.

1. The Property Is Overvalued

Real estate is very much a supply and demand business. If supply outpaces demand, prices remain flat or fall. The opposite is also true. When supply doesn’t meet demand, prices tend to rise. By extension, an especially hot market can lead to artificially high prices. We have seen this in the real estate market over the last two years.

What does this mean to a property investor? It means a piece of property they are trying to purchase may be overvalued. Its price may be artificially high due only to current market conditions. If a hard money lender feels that the investor is paying too much on a property, the likelihood of a loan being approved for that property is pretty slim.

Here is an example. Let us say an investor wants to purchase a piece of property valued at $500,000. Last year, the same property was valued at $400,000. The lender’s appraisal may determine that the price is artificially inflated by market conditions. They estimate the true value to be somewhere around $450,000. No deal.

2. As-Is Value Not There

A second way collateral could prevent an investor from getting a hard money loan is found in the as-is condition of the property. Some hard money lenders appraise properties in their current condition with no regard to what the property could fetch after improvements.

Actium Partners recently ran into this very situation. A borrower looking to obtain a hard money loan to finish developing a parcel of land was offering collateral that, in its current condition, would have been difficult to sell for enough money to recover the value of the loan. As-is, the value just wasn’t there. Actium passed on the loan.

Of course, there are some hard money lenders that will lend based on something known as after repair value (ARV). These are typically lenders who work with house flippers, commercial developers, and the like. Actium is not one such lender. Those that do lend on this basis still look at current condition, but they also try to estimate future value after improvements are made.

All Collateral Is Not Equal

The fact that collateral can sometimes scuttle a hard money deal is proof that not all collateral is equal. In order for collateral to secure a loan, lenders have to see enough value to protect their interests. If the value isn’t there, a loan will not be either.

The lesson for borrowers is clear: offer strong collateral if you expect to get a hard money loan. The value of your collateral is more important than anything else in the approval process.

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