Real estate investors typically seek out flexible financing to help them acquire time-sensitive properties. When they do, they are part of a consistent market pattern of using alternative financing options featuring premium pricing structures that can differ significantly from institutional bank options.
Investors throughout America’s most competitive markets, including Utah, consider hard money a very desirable alternative to traditional capital. There are many reasons explaining why. For example, one of the advantages of securing Salt Lake City hard money loans is speed. Hard money lenders are much faster to get to closing than banks and credit unions. But speed comes at the cost of premium pricing structures.
The Risk-Reward Dynamic
In the lending space, pricing is represented in a combination of three things: interest rates, administrative costs and fees, and down payments. All three tend to be higher in hard money. To understand why, think of the relationship between risk and reward.
Every form of lending is risky for the lender. Therefore, at the heart of every underwriting exercise is a simple law: pricing must be commensurate with risk. Lenders need to see the potential to earn enough money before they are willing to risk precious capital.
On one end of the scale are traditional banking institutions with models demanding the absolute lowest possible risk profile. By limiting risk, they can also offer moderate pricing. Hard money lending is on the other end of the scale. Lenders are willing to assume pretty significant risks in order to earn a good ROI.
How It All Plays Out
The risk-reward dynamic plays out in multiple ways. First, traditional lenders must jump through hoops to determine that a borrower is creditworthy. Second, they require a ton of paperwork verifying everything from income to tax history. Documentation equals safety to a traditional lender.
Actium Lending, a go-to source for Salt Lake City hard money loans, says that firms like theirs need very little documentation because they make approval decisions based on collateral. Risk is tied directly to the property being acquired with a hard money loan, for example.
Why Hard Money Presents an Elevated Risk
Premium pricing balances the risk for hard money lenders. But that does not explain why the elevated risk exists. Basically, there are three things in play:
- Minimal Borrowing Requirements – Because hard money lending is asset-based, borrowers face minimal requirements for approval. But that could mean a borrower’s income is nonstandard and even irregular. Such circumstances elevate the risk.
- Compressed Timelines – Traditional underwriting needs a lot of time to complete due diligence. However, some real estate investors do not have that kind of time. The market moves extremely quickly. They need to close in days, not months. Such compressed timelines increase risk.
- Non-Standard Properties – Investors are often forced to go to hard money lenders because they are looking to acquire non-standard properties that make banks nervous. There is elevated risk with these properties because they might be distressed, need significant rehab, or are not yet producing income.
The good news for hard money lenders is that managing risk is reasonable with the right pricing and underwriting structures. Hard money lenders around the country are not failing en masse because they are taking on too many risky loans. Firms like Actium Lending are managing risk and making a healthy ROI.
That’s good news for borrowers as well. A healthy hard money industry gives them access to the fast and flexible financing that fuels their investment or business strategies. They can move quickly because they’re funded more quickly. It’s a win for borrowers and lenders alike.
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