Hard money lenders offer all sorts of reasons for considering their lending model. Among them are speed and flexible underwriting. The speed part is pretty easy to understand. Hard money lenders can do in days what it takes months for traditional lenders to accomplish. But what about flexible underwriting?
When a hard money lender mentions this term, what does it mean? What are lenders actually talking about when they promote flexible underwriting? Think of it in terms of how loans are approved and structured.
Underwriting in a Traditional Scenario
In a traditional lending scenario, underwriting is the process by which a financial institution – usually by way of a loan officer or underwriter – evaluates the risk associated with a potential loan. From that evaluation come decisions about approval and loan structure. Underwriting is a service offered in exchange for a fee, typically represented in a traditional scenario as interest.
Underwriting is similar in a hard money scenario. An officer or employee of the hard money lender goes through a loan application for the purposes of evaluating risk. An approval decision is based on the underwriter’s discovery and analysis. Here is what makes it different:
- Traditional underwriting relies heavily on a borrower’s financial history and perceived ability to repay.
- Hard money underwriting relies almost exclusively on the value of collateral the borrower puts up to back the loan.
The differences in these two models explain why hard money lenders are more flexible. They are not locked into a rigid underwriting analysis that leaves little room for individual circumstances.
A Big Picture View
It is fair to say that hard money underwriting relies more on a big picture view where traditional underwriting is more detailed in its focus. Traditional lenders look at every single detail of a borrower’s financial position. Underwriters want to know about credit score and history. They want to know about current debt load. They want to know about employment history, weekly income, and so forth.
According to Salt Lake City’s Actium Lending, hard money underwriters don’t need to know every detail of a borrower’s financial past, present, and future. What they really need to know is how much the collateral is worth and its potential to cover their risk.
Let’s say a real estate investor approached Actium for a loan to acquire a new rental property. Right off the bat, Actium would want to know how much the property is worth. The firm might even go one step further and personally appraise the property. If it possesses enough value to cover the amount being requested, Actium can usually find a way to give its approval.
Lenders Can Be Extremely Flexible
The very nature of how hard money is structured gives lenders the opportunity to be extremely flexible. Using our previous example, perhaps the property being acquired doesn’t have enough value to cover the amount being requested. Actium might be willing to look at a completely separate property as collateral.
Actium Lending recently wrapped up a project in which the borrower actually offered two properties as collateral. The combined value offered enough to cover a short-term bridge loan that allowed the borrower to close on the new property while simultaneously trying to sell an existing property.
This is the kind of flexibility that makes hard money so advantageous for certain needs. Traditional lenders lack such flexibility. Their underwriting processes are so rigid that they just will not get involved in certain types of deals. These are the deals for which hard money is perfectly suited. Thanks to underwriting flexibility, hard money can do things traditional lending cannot.