Hard Money Loan Terms
This listing is a crash course in the basic terminology of the hard money lending market. Montegra has tried to list most of the key terms that are found on websites that discuss hard money lending to help new borrowers become familiar with how hard money lending (and Montegra) operates and to make their online research easier. If you have any additional questions about the hard money market, feel free to contact Montegra. Our representatives are happy to answer any questions you may have.
Direct Private Capital Lender – This is a lender who controls his or her own funds and underwrites the loans directly. Private money lenders do not fund loans for third parties or send loans somewhere else. (See the definition for “Loan Broker” below)
Loan Broker – This is an intermediary, or “middle man,” who collects information from prospective borrowers and then passes it on to a direct hard money lender, such as Montegra. They have no control over the funds, and they typically charge a broker’s fee of 1% to 2% in addition to the loan fees that are paid to the direct lender.
Loan Fee – Often called points, loan fees are charged by the private money lender at the time of closing and are deducted from the principal amount of the loan. These should not be confused with broker’s fees.
Loan to Value – This frequently used term refers to the ratio between the appraised value of a property to the amount of the loan request; it is often abbreviated as LTV. Here’s an example of how LTV ratios work: If a property has an appraised value of $1,000,000, and the lender only underwrites loans up to 65% LTV, then the maximum amount that the lender will fund is $650,000.
Non-recourse Loan – The majority of hard money loans do require a personal guarantee from the property owner (or, occasionally, from other individuals who are connected with the property or the owner and who greater personal net worth than the property owner). Such a guarantee grants the hard money lender the right to go after funds to repay the loan in the same way that a bank or any other institutional lender does. A non-recourse loan differs from other loans in that the lender does not require any personal guarantees from the property owner or borrower. While this type of financing is typical for loans of more than $10,000,000 underwritten by life insurance companies, it is much rarer to find it in the hard money lending market; however, Montegra will consider approving non-recourse loans on a case-by-case basis.
Cash Out Loan – This is a loan secured by a property that the borrower already owns but wants to refinance in order to “cash out” the equity and put it toward other business purposes. Banks are usually unwilling to approve this type of loan, but most hard money lenders are open to such requests.
Debt Service Coverage (DSC) – This frequently used term refers to the ratio between the monthly net income of an income-producing property and the required monthly loan payment; it is often abbreviated as DSC. For example, if a warehouse is leased and produces $1,100 each month, and the monthly payment on the commercial mortgage is $1,000 each month, then the property has a DSC ratio of 1.1. Most banks and institutional lenders require a DSC ratio of at least 1.1 or higher to approve a loan request. On the other hand, hard money lenders are much more flexible when it comes to DSC, and they will often consider creating an interest reserve (see definition below) to ensure that borrowers are able to make monthly interest payments on the loan until the property stabilizes and their DSC ratio increases.
Interest Reserve – Hard money lenders are often open to considering the option of holding back funds from the total loan amount to create what is called an interest reserve. These funds can be used to pay for all or a portion of the monthly loan payments until such time as the property’s income stream is stabilized and self-sufficient. This type of interest reserve is typically only offered by banks and institutional lenders for construction loans, but it can be particularly useful in situations where a property has a temporarily high vacancy rate as it gives the owner the necessary time to find more tenants and increase the property’s income production. It’s important to note that the total loan amount funded, including the interest reserve, must still fall within the hard money lender’s LTV criteria.
Commercial / Business Purpose Loan – This type of loan is secured by investment or owner-occupied properties such as warehouses, industrial buildings, retail shops, apartment houses, office buildings, or land that is intended for commercial or business use. All of the proceeds for this type of loan are considered to be business-purpose and, as such, can be funded by a hard money lender.
Residential Loan – There are two types of residential loans: personal-purpose residential loans (also called consumer loans) for owner-occupied properties and business-purpose residential loans (also called investment-purpose loans) for non-owner-occupied properties. State and Federal regulatory agencies stipulate that private capital lenders are only allowed to underwrite the second type of residential real estate loans (business-purpose loans). Examples of business- or investment-purpose residential loans include the following: a house purchase for resale at a profit or a single-family home, duplex, or fourplex rental property. Loans for these types of residential properties can be financed by a hard money lender under certain circumstances; however, regulatory agencies specify that hard money and private capital lenders cannot underwrite or finance loans against a residential property if the majority of the funds will be used for “personal, family, or household purposes” rather than business purposes. Please note that Montegra does not approve loan requests for residential properties that are owner-occupied.
Term Sheet – This document provides the borrower with a written summary of the loan terms stipulated by a hard money lender. These terms include interest rate, loan fee, length of loan, renewal options, and loan-to-value requirements. A term sheet is not a binding commitment by the lender to fund the loan request, but merely a description of how the potential loan would be structured.
Commitment Letter – This document provides a more detailed description of the terms and conditions of a loan once the borrower indicates that the terms presented in the term sheet will work for them. A commitment letter is more binding for both borrower and lender, and it may often require deposits to cover the lender’s due diligence items, such as appraisals. Commitment letters protect borrowers by assuring them that they will not encounter any surprises at the loan closing.