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Hesitant Banks Boost Hard Money Market

Hard money or private financing companies that make loans that banks would never touch are busier than ever these days.

“The activity we’ve had from our borrowers has definitely increased from a year ago,” said Paul Cortez, senior vice president trust deed division for Pacific Horizon Financial Inc., a Rancho Bernardo private lender specializing in these credits. Instead of loans based on a borrower’s credit scores, these loans are based on the value of the property pledged as collateral.

Cortez declined to disclose dollar amounts but said his firm’s total loan originations were up 300 percent last year over what they did in 2011. For the first quarter of this year, originations increased 46 percent over the amount in the first quarter of 2012, he said.

Pacific Horizon and similar hard money lenders say they’re benefiting from an ongoing trend of cash buyers in this region, many who are either fixing and flipping the properties and some that are buying, rehabbing and renting the houses.

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“The traditional sources aren’t lending to these clients,” Cortez said. That’s because banks require volumes of documentation and verification of a borrower’s credit history before approving a loan. Since the onset of the recession, banks have eschewed construction lending as well as any type of speculative development lending.

Higher Interest Rates

Another factor boosting volumes at hard money lenders is convenience. Getting a loan from a bank these days can take at least a few weeks, or months. Most hard money lenders say they can get a deal done within a week.

There’s a price for all this in the form of higher interest rates. Pacific Horizon charges 9 to 12 percent on loans that max out at one year.

That’s suits most of Pacific Horizon’s borrowers since they need the money for only six months, and many times far less time, Cortez said.

James MacArthur, owner of The Hard Money Pros in San Diego, said the financial crisis that occurred in 2008 greatly helped his business.

“After that, the banks were so tight and not lending money at all, and it drove a lot of customers my way,” MacArthur said. “It’s slowed down a little bit as the rehabbers are having a harder time acquiring beat-up properties to fix up.”

MacArthur is a direct lender, which means his firm lends the money from its own funding pool. Many hard money lenders, such as Pacific Horizon, act as intermediaries or brokers, matching investors with borrowers on the loans.

Much Needed Service

Pacific Horizon arranges the matches, with investors putting up $100,000 to $1 million, but a typical investment is closer to $100,000, Cortez said. Pacific Horizon charges origination fees of 2 to 4 percent on the loans and services or collects payments on the credit.

Hard money lenders say they are providing a much needed service to borrowers who are blocked from getting funding from other sources.

“Just try to go to a bank and get a loan on a house that’s got a cracked slab,” MacArthur said. “And no bank is going to do a loan on a house that doesn’t have a furnace or a bathroom.”

Getting a loan in a short time is essential to most hard money borrowers, he said. “People who come to me for a loan can get in three to five days, and that’s where my value is,” MacArthur said.

Yes, the cost of that loan is high compared with traditional banks which are charging below 4 percent on a 30-year mortgage, but most borrowers in the fix-and-flip deals need the money for about three months. “That’s 1 percent a month, so that’s 3 percent for the three months,” he said.

Bruce Norris, principal of the Norris Group in Riverside, said bridge lending in the region is seeing increased competition from a few hedge funds, and private equity firms seeking better yields.

‘Program Has Exploded’

In reaction, Norris reduced his origination fees from 3.5 points to 2.5 points, and is getting plenty of takers.

“Our hard money loan program has exploded this year,” said Norris, whose firm invests and provides consulting on California real estate. Besides providing loans on properties that require upgrading, Norris also provides loans for buying rental properties, another type of lending many banks avoid. Terms on those loans can be eight years, and average 9 percent annually, he said.

Traditional lenders are focused on extending loans to owner-occupants of the houses. The banks also carefully scrutinize borrower’s credit worthiness based on their past history. So borrowers without easily verifiable and predictable income, such as fix and flippers, look like a high credit risk to banks, Norris said.

Also, because of restrictions by government sponsored entities Fannie Mae and Freddie Mac that buy most mortgages, banks limit investors to only 10 loans, Norris said. Not so hard money lenders, who are regulated by the state’s Department of Real Estate, but not as tightly as banks.

Norris said his current portfolio of hard money loans is about $50 million, up from about $45 million a year ago.

Low Default Rate

The default rate of his bridge loan borrowers is extremely low, less than 1 percent, he said. Cortez said his firm hasn’t had a default in the past four years.

Greg Garrabrants, chief executive of San Diego-based BofI Federal Bank, said his bank participates indirectly in hard money lending by providing loans to some financing companies that do hard money loans. BofI Federal mitigates its risk by taking the first position on all the trust deeds it provides the loan on, and extending far lower funding amounts based on the value of the properties, Garrabrants said.

“We never do a loan for greater than 40 percent of a property’s value,” he said.

While some hard money lenders may have a negative image (related to the loan’s high cost), Garrabrants says the companies serve an important function.

“They work with lots of borrowers that banks do not want to work with and that mainly involves houses that are in need of repair,” he said. “Their biggest advantage is the level of service and the speed that they can close.”

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