However, there are times when a hard money loan makes sense, a lot of sense.

“We’re Out of Time”

Hard money loans are the most effective when time is short. Borrowers or real estate investors that don’t have time to wait for the conventional loan approval should consider a hard money lender.

This situation most often arises when another lender is unable to come through on their promise and a transaction is in danger of falling out of contract. Sometimes this can arise when an opportunity to purchase arises and a discount is offered if the property is closed on by a certain date. This can also arise in the situation of a 1031 exchange, where the purchaser needs to close prior to a looming deadline.

Because hard money lenders use private capital to fund their loans, their organizations are usually much flatter. This means that loans get approved much quicker. So a deal that might take weeks to get approved at a bank, can be closed in a matter of days for a direct private lender.

A Diamond in the Rough

Many real estate investors look for properties that are in need of a little TLC (tender loving care). They need work. Maybe the building is in need of repair or it needs to be reconfigured to maximize the value of the property.

However, with a little bit of vision and a lot of elbow grease this property will be worth significantly more than what the investor paid for it. These are value add deals. The investor adds value to the property and is able to realize the gain through either higher rents or a greater sales price after repairs or upgrades are performed.

These deals too are a good fit for hard money lenders.

Most hard moey lenders are “real estate guys”. They understand real estate and have a good handle on it’s value.

If a deal makes sense and the lender can see the properties future value, then the deal is likely to be approved. However, don’t expect to do many 100% financing deals with hard money lenders.

Cross-Collateralized Properties

Sometimes a borrower does not have enough equity in a single property to get the financing necessary for his needs. Many real estate investors own multiple properties and some of those properties may have a significant amount of equity.

A hard money lender can use one property as the primary collateral and a second property as additional collateral to secure the loan. The properties are said to be “cross-collateralized”.

Because most private money lenders understand commercial real estate value, they are able to be creative and provide these types of solutions.

Getting Deals Done

Hard money lenders are not a good fit for every deal. But in some cases they can provide the best solution to get a difficult deal financed. Borrowers that are facing a huge tax liability for a 1031 exchange gone sour may think a hard money loan fee a small price to pay  in comparison to Uncle Sam’s bill.

This is a post from Peter Maclennan's blog Peter Pays Paul.

3 Reasons to Use a Hard Money Loan

Hard times for hard-money lender | OCRegister.com.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Another Unscrupulous Hard Money Lender

Trial for Paso lender Estate Financial pair delayed, co-owners remain in jail – Breaking News – San Luis Obispo.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Estate Financial Court Trial Delayed

I realized as I was at home and with friends that from the title of the post, it may have seemed that I was advocating not paying your mortgage.

This was not my intention at all.

Viewing Money and Wealth as a Tool

I believe that there are many things in life more important than money.

My love for Jesus helps me to view money not as and end in itself. Money is a tool that allows me to eat, stay warm, and accomplish bigger goals in life.

Wealth is not an end in itself. Wealth (an abundance) makes eating, staying warm, and accomplishing bigger goals easier. It can often provide an easier solution to the problems that we may face.

A Good Reputation is More Valuable Than Gold

A good name is to be chosen rather than great riches,
and favor is better than silver or gold. – King Solomon

Thousands of years ago King Solomon wisely wrote that a good reputation is more valuable than great riches. Riches and wealth may come and go, but a person’s reputation can outlast their life.

A good reputation is an inheritance that even a poor man can pass along to future generations.

Keeping Our Word

Keeping promises is something more important than money.

A mortgage is a contract or promise between two people. The lender promises to lend money to the borrower in return for an interest payment. The borrower promises to repay and compensate the lender with interest for the use of the money.

Should a borrower purposely stop paying their mortgage or lower their income in an effort to get “better terms” or a “more affordable” monthly payment they are going back on their promise to repay their debt.

Doing it Right

Most of the time I am a stickler for doing things “the right way”. This has a tendency to frustrate those closest to me who may just want to get the task accomplished.

Accomplishing tasks with excellence breeds a sense of personal accomplishment over a job well done. No corners were cut, no task was left undone, this project is fully completed.

Getting a better mortgage payment may be financially better now. People might think you are crazy to not take advantage of the situation.

It can be done right, or it can be cut short.

If “shortcuts” are taken, we truly only short change ourselves.

Blinded By Nearsightedness

Too often it is easy to look at the near term benefits and forget the long term consequences when thinking about our money and finances. I too often fall into this trap. I look for the easy fix now, rather than the long term benefit.

The current government loan modification may cause us to be blinded to the long term consequences on our character and the character of future generations.

Subtly, we may be teaching those that respect us the lesson that doing whatever it takes to make more money and acquire more stuff is the highest and best goal and anything should be done to accomplish it.

Wealth in the Journey not the Destination

The pursuit of wealth and all that is shiny can be so very attractive for what it offers. However, the journey to achieving wealth is probably just as important as the wealth itself.

Wealth alone cannot produce character, while the journey to wealth can.

Of the billionaires I have known, money just brings out the basic traits in them. If they were jerks before they had money, they are simply jerks with a billion dollars. – Warren Buffett

In the journey we develop character, perseverance, and humility. So let’s enjoy the journey, keep our promises, and do it right.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Some Things are More Important Than Wealth

I’m talking about those rare occasions where you need money and you need it fast.

If you are a commercial real estate sales agent or commercial loan broker, what do you do? Do you know who to turn to in a pinch?

In baseball many teams have the left-handed specialist who will come into the game to get one batter out.

Basketball teams have their specialists as well. The Chicago Bulls had Michael Jordan. The Lakers, Kobe Bryant. Who is your “Go-To-Guy” when time is short and you need a “sure thing”?

“Clutch”

Coaches depend on “clutch” players that will perform when the game is on the line.

Do you have a lender you can depend on when there are 10 seconds left and you are down by two? Do you have a “clutch” lender that understands real estate and can salvage a deal when your client’s deposit is on the line and close of escrow is days away?

Built for Speed

Most hard money lenders are built for speed. Some models of business are faster than others, but in general this is one of the advantages of hard money.

Because most private money lenders don’t have FDIC and state banking guidelines to follow they can underwrite and make a decision much faster than a bank. This allows them to fund deals much faster than a bank.

Always Be Prepared

No one plans on a deal going sour at the last minute, but it is good to have a plan for a “what if” scenario.

Like the Boy Scouts’ motto Be Prepared, commercial real estate specialists should have a tool for every situation. Having a relationship with a hard money lender for deals that require them is just another tool in the commercial real estate professional’s belt.

The Essence of a Professional

Which do you think sounds more reassuring to a client and more professional?

“I never have seen this situation happen before. I’m not sure what to tell you Mr. Borrower. I will have to get back to you on our options.”

Or

“Mrs. Borrower this situation rarely happens. However, I have developed a relationship with a lender that specializes in closing loans quickly. They are a more expensive than bank financing, but they will allow us time to find a more permanent solution.”

Quick Close Scenarios

Mr. O’Skool Mr. O'Skool is an experienced real estate investor. He is very "old school" and doesn't like much leverage. He speaks slowly and always has interesting anecdotes about life. He drives a late model station wagon and brags that he has a second matching station wagon at home in the garage. You are not sure you have seen him without a sweater on.

Mr. O'Skool owns a variety of properties He owns two apartment buildings free and clear. Through his network he learns that another apartment house is available for purchase. He knows that he can purchase it from the current owner if he closes in 15 days time at a 15% capitalization rate, otherwise the owner is going to list it on the market.

Can you get Mr. O'Skool the money he needs to purchase the property in 15 days?

Ms. Forshewnat

Ms. Forshewnat is a very successful real estate investor. She began with a few properties her late husband left to her and has parlayed that into a multi-million dollar real estate empire.

Through the grapevine you have heard that she is not extremely pleased with the service she has received from her previous lender. You have been courting her business for a while and she has finally agreed to allow you a chance at winning her business. She tells you that she is has other notes coming due in the coming months.

She has asked you to finance an office building she owns as the note is coming due in 120 days. You take Ms. Forshewnat to one of your lenders that has a great program for office buildings.

Everything is moving along without a hitch until the lender runs a new credit report 20 days before closing. It seems that Ms. Forshewnat co-signed a loan with her 23-year old son who has missed two of his payments. Now her credit score has dropped and the lender is unable to extend financing.

Can you find a lender to close in 20 days in order to keep Ms. Forshewnat from having a default and jeopardizing future loans?

Buying Time

In general, hard money is not a long-term solution. But it can buy you time to find that permanent solution.

Having a reliable, direct hard money lender can be invaluable to commercial real estate professionals.

This is a post from Peter Maclennan's blog Peter Pays Paul.

The Need for Speed – Hard Money Solutions

Like all disasters, the financial crisis has its share of beneficiaries who profit from it. The hard-money lenders, who lend strictly on the basis of collateral, have profited from the financial meltdown. These non-institutional lenders require a lot less paperwork than institutions because they don’t worry about whether or not borrowers can afford the payments, or whether or not they are creditworthy.

Read the rest of the article..

I would mostly agree with Mr. Guttentag. However, with the value of real estate hard to determine in a falling market it is also a potentially treacherous time for lenders as well. Making a loan at a high LTV on a property that is decreasing in value can be risky, because equity can be eroded quickly.

I can attest that we have seen an increase in the quality of deals that we are reviewing. However, many of the existing financing was underwritten at lower cap rates and higher values. (Remember that cap rates and values have an inverse correlation of each other. As cap rates rise value falls.)

Now with higher cap rates and lower values these properties are worth less than when the original mortgage was put in place. Without an injection of equity from the borrower many of these loans are unable to be refinanced.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Yahoo! Finance “Good Times for Hard Money Lenders”

California Cities Cut Police Budgets – WSJ.com.

This is just one of the effects that cities are experiencing due to lost revenue from development fees and property tax revenues. City councils bought into the myth that real estate would continue to go up in value indefinitely and city services would be adequately funded.

An underfunded police force will likely affect real estate values in Vallejo and other municipalities like Vallejo. If crime rises and the perception of safety decreases, real estate values in some areas of Vallejo will likely decrease as neighborhoods become less desirable.

This could be an unending downward spiral for cities as property taxes are assessed on transfer value in California due to Proposition 13. Lower real estate values would generate lower property tax revenue and the city would have to cut more costs from their budget.

This is a key reminder to real estate investors that local government issues can affect long-term real estate values.

Deals in cities with bankrupt or poorly funded city coffers should be given a higher degree of scrutiny and underwriting.

This is a post from Peter Maclennan's blog Peter Pays Paul.

California Cities Cut Police Budgets – WSJ.com

This is a post from Peter Maclennan's blog Peter Pays Paul.

Defunct Hard Money Lenders in Central California

His friend said, “DiMartino recently began a side business in real-estate closings, title searches and ‘hard-moneylending’ – high-interest loans to people unable to tap traditional credit sources.”

Are real estate investors that desperate to get out of debt that they would commit murder?

This is a post from Peter Maclennan's blog Peter Pays Paul.

Hard Money: A Dangerous Career?

These exchanges allow the borrower to apply more of the proceeds from the sale of an existing investment property to the purchase of a new investment property.

1031 Exchanges Defined

This is an explanation of an 1031 exchange according to the IRS website:

Generally, if you exchange business or investment property solely for business or investment property of a like-kind, no gain or loss is recognized under Internal Revenue Code Section 1031.

My explanation in a nutshell: a real estate investor can sell a piece of investment property, defer the capital gains tax until a later date, and roll the entire gain into the purchase of a new piece of investment real estate. The taxes are deferred (postponed) until the investment property is sold the final time.

Benefits of 1031 Exchanges

Deferring the taxes due on capital gains (appreciation) can reap huge rewards over time. Deferring payment of capital gain tax allows the savvy investor to apply more capital towards the purchase.

Leverage should allow the investor to generate a higher return through appreciation and/or cash flow.

1031 Exchange Hurdles

Now of course the government doesn’t make it an easy process and sets limits and restrictions on how a 1031 Exchange must be executed.

One of the main restrictions is the timing on completion of a 1031 Exchange. The exchange must be completed within 180 days of the transfer of the exchanged property. This deadline can put pressure on all involved to complete the deal within the 180 day period.

The costs of missing this deadline can be large. The borrower will be forced to pay capital gains tax on any gain as well as any penalties that might be incurred if the contract date is not met.

Most exchangers will typically qualify for standard financing. However, on occasion an institutional lender will be unable to provide financing within the mandated 180 days.

Using a Hard Money Loan to Execute a 1031 Exchange

If the primary lender is unable to close on time, what is the investor to do?

One of the benefits of using hard money is the speed that hard money lenders provide. A hard money lender that lends their own funds and is well operated can provide commercial financing within 14 days of receiving a complete package.

Another benefit is that most lenders offer loans on a short term basis. The hard money loan can help an investor close the transaction while a more permanent loan is arranged.

While the fees associated with hard money may be higher than a traditional source, the benefits of completing the transaction within the mandated time may outweigh the costs.

1031 Example

The following example should help demonstrate my point. Below are the assumptions we will use for our example.

Below are the costs that would be associated with a failure to execute the contract on time. I have only included what I would cite as the most basic and immediate costs. (There would be the potential loss of future returns as a result of cash flow and/or appreciation.)

The current capital gains rate is 15% but is set to increase in 2010. By including the deposit I am assuming that the deposit became non-refundable at some point.

Below I have computed the after tax costs of a hard money loan. The pricing below is on the high side for a short-term, conservative LTV loan.

Conclusion

As you can see from the example the after-tax cost of hard money may be less than the cost of not executing the 1031 exchange on time.

Hard money is not the best option for all scenarios. When a deal is on the line and speed is needed, hard money is a good alternative to institutional financing.

For more information head on over to Jeff Brown’s blog to find out more about 1031 exchanges and when to execute them.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Using Hard Money to Execute a 1031 Tax-Deferred Exchange