Is this Hard Money Lender as Dodgy as He Seems?

15 Replies

Will try not to waste people’s time with unnecessary details. Basically, I am embarking on a project where I am entitled to 50% of the property, and I am needing to use hard money to borrow fix-up costs to get the property out of a distressed state before obtaining permanent, conventional financing. The hard money loan is for $150,000. The important thing is, after applying the new, first-position lien for the hard money loan, I would still have about $250,000 of equity in the property.

So I just emailed the hard money lender two questions about the “loan charges” listed on the not-yet-finalized settlement statement that the Title company just sent out, and I’m a little concerned by the responses. Is there something I am not understanding about this?

(1) A new, previously undisclosed “contingency reserve” for $9000 or 12% of what was supposed to be the funds to me from this transaction. I asked for clarification and he said, “That’s the interest reserve.” Why would there be an interest reserve when the collateral is already $250K?  Mathematically, it seems to be six months of interest, but . . . someone is afraid that they are ONLY getting $250K from a default rather than $259K? I’ve lent money before and there was no “interest reserve” for me. The idea seems somewhat silly to me. “Prepaid interest” is a thing: that means my first six months are paid and I don’t have to worry about paying for six months. But with this they will surely foreclose on me if I don’t pay the first month or two. So . . . basically I’m just borrowing less money at a higher interest rate, right? This kind of thing only makes sense to me if the lender needs to collateralize the loan somehow; if the lender is already turning $150K into $400K why would they need to further collaterlize the loan? Are they really trying to protect themselves in case of default? Or are they trying to encourage default by reducing my funds?

(2) There was a previously undisclosed “draw holdback” of $60,000. I asked what this is, because I didn’t know, and he said, “I can remove the $60,000 holdback and release all of it to you.” Gee, thanks. The new $60,000 holdback and the new $9000 reserve are equal to more than 100% of what the funds to me would have been. So . . . you’re just trying to get me to default, right? I mean, after I asked about it he generously offered to let me have the money I was paying to borrow, but if I hadn’t said anything he’d be getting first position lien on the house while giving me literally nothing in return.

Am I missing something? Or is this as dodgy as it seems to me?

@Michael Ede this doesn't seem too off the mark. If anything the representative of the lender didn't properly explain/understand the structure of the loan provided.  The interest reserve is used with lenders when and if they believe you don't have the income to support the monthly loan payments. To protect yourself, make sure there is something stated in the loan docs showing that the reserve will be set aside for the first 6 months of payments.

In regards to the $60,000 hold back, some lenders want to manage the construction process and mitigate the possible misuse of funds. It seems like the lender wants to see 50% or so of the work complete before issuing the final draw.. you may want to clarify.

Hope this insight helps!

Thanks for the reply. 

Like I said, an “interest reserve fund“ might make sense to me in some situations. But not in a situation where there is already a lot of collateral. Interest reserve fund basically means you will at least get your first 6 months of interest payments. If your $150K just turned into $400K, then why do you care? It doesn’t make sense to me. People do loans where the property is being bought for full price all the time without “contingency reserves.”

And, as for the “holdback,” the idea that the person who gains a quarter of a million dollars if I run out of money gets to decide if and when I get my money? That is ridiculous.

And most importantly, this guy had things set up so that I would not get any money from the loan. He would get the lien on the house and I wouldn’t get money for fix-up, money for reserves, or even money to pay the interest (because “interest reserve” doesn’t mean I don’t have to pay interest.)

Interest reserves are usually something borrowers ask for .. as cash flow is usually an issue..

when I borrow money from my West coast bank they are happy to give me 9 months interest reserves and since I am borrowing 7 million over 20 loans this is a real big cash flow help and since I am paying 5.5% interest its negligible on the interest the bank earns .. now my East coast bank they wont allow interest reserves and they want monthly payments.

hold backs for construction are the way these are done.. equity does not matter.. NORMALLY...

nothing worse than foreclosing on a half built house equity can go poof real quick.

When you are talking about equity in the property, are you talking about as-is value or ARV? Anything based on the ARV is speculative until achieved. HMLs are more strict on refinances and cash-outs, and they won't give you more money up front than what the property is currently worth (and the rest of the money will be a holdback), otherwise, they'd be underwater from the get-go.

They should have been more upfront to you about everything.  The fact that you're surprised by these things means the rep you were working with didn't do a very good job.

Are they making you take an interest reserve because you have low liquidity?  Either way, you're not in default if you have an interest reserve, only when it runs out (since they will technically draw on the interest reserve to pay the interest each month).  So they can't foreclose on you based on that.  But it's true that anything they add to the loan amount will mean higher points and interest amounts for you.

I'm not sure if they're trying to get you to default... most HMLs are not in the business of owning properties.  But if you disclose the name of the lender we can give you some thoughts as to whether or not they are legit.

When I talk about equity I’m talking about the as-is value. Oddly enough the hard money lender offered to buy the property as-is.

Is there a local hard money lender you’d recommend? 

that is really weird not so sure that is a true HML that's some what of an industry NO NO..

Unless you offered it for sale. Nothing in the rule book but most real lenders wont underwrite you get you to the finish line and then just say.. well you know I will just buy it.. something strange there.

@Michael Ede

It sounds like you should run away from this HML if they're wanting to buy the property... seems like a conflict of interest there. You should let BP know of the name of the HML so we can all stay away as well.

I've PMed you regarding the hard money lenders earlier.

@Nghi Le   yes that's pretty much an industry NO NO unless this guy asked them if they wanted to buy it.  but to underwrite a loan then say Hey we will buy it.. that's not in a true lenders bag of approved tricks.

Equity doesn’t translate into making monthly interest payments....your equity is irrelevant to this.

I guess I’ve never seen a foreclosure up close, so maybe I’m misunderstanding how the process works. I would have thought that after six months of not receiving any payments you would have already foreclosed and gotten the $250,000. 

Hi, @Michael Ede 1) A lot of lenders do have interest reserve, but not to 6 months, normally 1 or 2 months of interest. The only reason is that make sure the interest get paid. 2) Rehab draw is practical because lenders want to make sure the money has been spent on the property.  3) If the lender want to buy the property from you, that is a red flag and it is conflict of interest.  

Originally posted by @Frank Yang :

Hi, @Michael Ede 1) A lot of lenders do have interest reserve, but not to 6 months, normally 1 or 2 months of interest. The only reason is that make sure the interest get paid. 2) Rehab draw is practical because lenders want to make sure the money has been spent on the property.  3) If the lender want to buy the property from you, that is a red flag and it is conflict of interest.  

 my construction lender has been giving me 9 month interest reserves for the last 20 plus years its quite common and totally negotiable.. as is all things real estate..

There are some lenders that are called "LOAN-TO-OWN Lenders"

They Give You A Loan Knowing that You Will Fail and Go Into Default and Foreclosure

Then They Take Over the Property with a loan at 80% LTV or 65% ARV.

Full interest reserves are very common in construction loans. We work work with HML that require the same. My guess is they don't have or want a monthly interest billing department and possible have to do monthly payouts to their investors. The reason people go to a HML is because they cannot qualify for conventional financing . This doesn't mean HML terms are going to be better or easier to get. In most cases it's harder and stricter. I know one HML who charges a minimum $15,000 fee for a no doc loan at 50% of appraised value.

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