Repercussions of Defaulting on a Hard Money Loan

[James H.]

I have been considering the idea of using HMLs in the future. Not that I would plan to, but I was hoping some of the HMLs or folks with experience borrowing from HMLs could describe what happens if you default.

So far, this is my understanding of the use, benefits and risk of using hard money:

1) + access to cash you don't have or do have and don't want to tie up.

2) + Short term financing that can be used same as cash for discounted purchases and expediting closings and ability to purchase properties otherwise not financeable with a mortgage due to property condition.

3) + Short term financing for rehab costs.

4) + Debt that does not count against your debt to income ratio when looking to refinance the property after rehab is complete.

5) + Refinancing terms of HML is typically easier than doing a cash-out refi.

6) – Terms/up front fees of Hard Money demands higher margins on a deal.

7) - Most hard money is for 6-12 months, but mortgage lenders may require up to 12 months seasoning which would create a default on the HML or a fee generated to extend the HML if mortgage lender required 12 months seasoning. (unless you could refi exactly the same day that HML expired ).

8) - One cannot be certain that long term financing will be available for long term hold investors even once seasoning has been satisfied.

9) - Less experienced rehabbers may not have enough experience to flip a house in time or within budget to not default on the loan.

10) - HMLs will require a licensed contractor to do the work so DIYers can't save by doing the work themselves.

So this is my general understanding of Hard Money and how it can work for and against an investor. I may not be right on some or many points - please correct me where I misunderstand.

Ultimately, what happens if you default on the HML and/or can't afford to pay an extension? I assume that the HML takes the property and you loose any cash you have invested in the deal. What other negative repercussions usually happens and/or could happen?

[Travis Sperr]

Hi Brian,
I am a hard money lender in CO, it can be very different in TX.
I agree with all of your positives- of course. But would like to comment on some of the potential negatives

6)- Points and fees can be seen as an opportunity cost. Of course we all ideally invest in real estate with no money out of pocket, but better to pay to do a great deal than not do a deal at all. The larger margins are important for the lender to protect their investment, as wells as yours. If you plan to refinance, the rate and term is going to require some equity, in our market it 75% LTV, we lend 70%

7-8)You can work with a mortgage broker to see what you will be qualified for on the refi, look for lenders with no title seasoning. Without title seasoning you can use HM to acquire and repair, then refi to long term money 30 days after your work is complete. Wash, Rinse, Repeat and keep acquiring rental properties without putting 25% down.

9) Work with a lender that wants you to be successful. I look at every clients deal to ensure they will be profitable, there are always unknowns but another set of eyes on a deal doesn't hurt.

10) In our business as long as the repairs make sense and the dollars allocated are appropriate, I have no problem with the investor doing their own work.

Most HML's do not report to credit on the loan, too short of a term and too much work to report. Although in the event of a default it is a full foreclosure and it will affect credit.

The secret is, in 99% of loans the lender doesn't want the property and will probably work with you to extend. If you are priced right and understand the business there is no reason a loan should go to term.