The truth about that hard-money loan refusal.
There are many legitimate reasons to use a hard money lender. Compared to traditional lenders, hard money lenders can offer faster funding, flexible construction draws, no prepayment penalties, and a willingness to look beyond a specific borrower’s credit blemishes. This might beg the question, “When would a hard money lender turn down a deal?”
Daisy chain: In real estate, a deal that has been contracted to multiple parties before the end buyer.
“Daisy chain” wholesale deals are a red flag. A single-wholesale transaction does not represent a problem. However, once two or more wholesalers are involved in a deal, we begin to wonder if the seller knows all the facts around the property. These deals are unlikely to close and full of unknowns, so we steer clear.
Our most common reason for turning down a deal is because we don’t believe in the borrower’s projection of repair costs or their after-repair value (ARV) estimate. If something else seems amiss, we spend a lot of time figuring out what is going on with the transaction. Here is a short list of our “rules of thumb” for turning down deals and examples of each:
Refusal Rationale #1 | Title Issues: Clouded Titles and Wholesale “Daisy-Chaining”
It is an immediate red flag if a title review by a third party is not permitted. A title company once told us that the title report was not subject to our third-party legal review and all titles have problems, which is why they sell insurance. We turned and ran. What would happen if we had needed to clean up a title problem after a closing? Sure, we could make a title claim. However, waiting for a title company to resolve a title issue is difficult and we might have to hire our own attorney to expedite the process. If we must take back a property, the title must be clear. Therefore, we refuse to start a process with title issues.
Lesson Learned: Your hard-money lender will always try to avoid uncertainty.
Refusal Rationale #2 | Contractor Knowledge: Plans and Permitting
If a borrower suggests that they can outsmart a municipal inspector, we turn that deal down right away. We have had prospective borrowers insist that they can do their construction without permits and that it is perfectly legal. Possibly so, but we won’t do the deal if they insist on proceeding without proper plans and permits. If a borrower is taking over a job that has already begun, then we will need to see copies of plans, permits, construction draws, and inspections. We may loan on a job that has been done with “inadequate” permitting so far, but only if the situation is set to rights before we get involved.
Lesson Learned: Hard money lenders are sticklers for legal minutia because they must be.
Refusal Rationale #3 | Investor Ability to Execute and Cross-Collateralization
If your latest project is much larger and more complex than any you’ve done before, that’s not a deal-breaker automatically but it is a red flag. We talk to prospective borrowers and review projects they have completed to determine if they are similar in scope to the one that is being planned. We look to see what type of team they have assembled to make it a success.
Similarly, we are not comfortable when borrowers take on too many projects at once, so we review everything they’re working on with us even if those projects are not under the same “management,” so to speak, because they are held in different LLCs. This is a common asset protection technique and not a negative in and of itself. However, we want to make sure that a default on one project just does mean a default on all projects secured with us! If you have so many balls in the air that you are cash-poor and loaded down with debt obligations, we will want to discuss your latest project’s viability before making a loan.
Lesson Learned: When investors succeed, hard money lenders succeed. We won’t loan on projects likely to fail.
The Hard Truth: We might view 20 deals before we find one that we want to lend on. Usually, we refuse loans because the values won’t work, but sometimes the deal just presents too many other risks. Understanding what a lender is looking for should help real estate investors seeking to secure their next loan.