Hard money lending has traditionally been used as a short-term funding option for borrowers who have been seriously delinquent on a prior loan and are unable to refinance into a new, conventional loan.
However, with the slowdown in home price appreciation, and increasingly stringent underwriting standards, this alternative lending strategy might not be the "knight on a white horse" that borrowers expected.
When issues in the subprime mortgage market first arose in February, there was speculation that the market could see a rise in hard money lending. If delinquent borrowers with weak credit profiles were not able to refinance into another subprime loan, they would be forced to post their house as collateral for this short-term, high-rate, financing alternative to repay their outstanding debt.
"A hard money loan is an act of desperation, taking a really onerous rate, putting up a significant amount of your equity against it, but in theory, you are supposed to be curing your credit," a mortgage market participant said.
However, tighter underwriting standards may prevent borrowers from doing just that. "In the past, a borrower might have taken a [hard money loan] out as a bridge loan," said Rui Pereira, managing director at Fitch Ratings, noting that after demonstrating some cleaner payment history the borrower was typically able to refinance into a loan with better terms.
However, right now, it is much more difficult to pull out that refi, he added. "Even if you have demonstrated some cleaner payment history, everyone's underwriting guidelines have also been tightened, so it will be difficult for a borrower to refinance into a loan with better terms." Traditionally, many of these smaller institutions like Franklin Credit Management Corp. or Yale Mortgage Corp. tend to be finance companies that have not been regulated.
At the same time, while hard money lending, in theory, should see a rise in applications as adjustable-rate mortgages begin to reset at higher rates, the increasingly stringent mortgage regulations, rising scrutiny on business models, and heightened risk aversion might put pressure on lender financing.
"If you take into consideration the guidance that the mortgage market is getting from the regulatory bodies, for example the interagency guidance on subprime lending, it makes it difficult to do this type of product going forward because you do have to underwrite a loan based on the borrower's ability to repay that loan and not necessarily to the collateral value," Pereira said.
Garbage In, Garbage Out
Indeed, with the low FICO and LTV data that has characterized hard money loans, the credit of the borrower has historically been of secondary importance to the lender compared to the value of the property, according to a Countrywide Financial report issued earlier this year.
In the past, these loans, which were heavily centered in California - the bull's-eye of the subprime troubles - were almost all stated income loans, Countrywide said. To be sure, Agoura Hills, Calif.-based hard money lender Quality Home Loans, which filed for Chapter 11 last month, did not require a minimum FICO score or mortgage or income history, and it accommodated borrowers with stated income who were either in bankruptcy or one day out, according to its Web site.
However, the value of the property may no longer be an asset to lenders, the mortgage market participant said. "Most of the time, [hard money lending] is for people who have some consistent appreciation, and in this case I just don't think there are enough people out there with equity in their houses to look at this as a real option," he said, adding that a lot of these borrowers probably have negative equity right now. "There are a decent amount of 100% LTV loans that were done in 2006 as purchase loans. Those people are probably under water at this point, so the notion that the hard money market is going to ride to the rescue is not true."
Further, those already assisted by hard money loans are not faring well. Coconut Grove, Fla.-based hard money lender Mortgage Asset Management Corp. (MAMC) reportedly has about $192 million in loans that it is trying to work out and has asked the clients who financed its real estate loans to provide funds to keep the company going. Calls to Chief Restructuring Officer for MAMC Alan Goldberg, of Miami-based Crisis Management, were not returned by press time.
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