Originally published Sep 30, 2016. Republished August 13, 2018.
Hard money lenders are very reluctant to provide 100% financing on a deal. When prospective borrowers say they need 100% financing, they're raising questions about how much skin they have in the game.
When the real estate bubble collapsed in the Great Recession, housing values declined rapidly and many homeowners discovered that they owed more on their mortgage than their property was worth. Many decided to walk away from their properties and let them go into foreclosure. That domino effect ultimately led to the worst economic crisis since the Great Depression.
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The economy may have recovered since then but serious problems remain in the real estate world. These days, gullible borrowers and investors may be susceptible to real estate gurus offering to teach them how to invest in real estate without using any money of their own. They shouldn't fall for it.
Here are three reasons (or red flags, depending on your point of view) why hard money lenders won't provide 100% financing.
When a borrower asks for 100% financing, it calls the borrower's financial strength into question. If the borrower doesn't have or isn't willing to commit liquid cash to the project, the lender will wonder about the borrower's ability to repay the loan. Reputable lenders will also want to see financial statements to ensure that the borrower has an ample cash reserve set aside to deal with any unforeseen issues that may arise.
Hard money loans are underwritten based upon the value of an underlying property. The loan is secured by the property (also known as the asset) as the collateral for the loan. If the borrower retains little to no equity in the property, the lender will have to assume all the risk. Lenders typically want to reduce their risk whenever possible so they can retrieve their investments and continue lending money.
If the borrower owns a property but has no equity in it, any decrease in value creates the potential of a loss for the borrower. If the borrower has no equity in the property to protect, he might abandon the property and leave the lender high and dry.
Borrowers who think they can obtain 100% loan-to-value (LTV) hard money loans are dreaming. They're clearly misinformed about what is needed on a hard money loan. Just as troubling, they'll probably find themselves in over their head in no time.
The borrower's inexperience increases the likelihood that the borrower might make mistakes that will cost both the borrower and the lender money and time. There is even the chance that the project itself could be put in jeopardy.
Borrowers with some real estate investing experience know full well that lenders do not provide 100% of the funds to purchase a property.