Reading different explanations of why hard money is so named can be amusing. I have read explanations ranging from the nefarious to the completely absurd. In the end, the real explanation is pretty simple. It has to do with borrower assets and how they relate to loan approval.
Before getting to the explanation, understand that hard money is provided by private lenders. It is not the domain of banks and credit unions. Also note that many hard money loans are structured as bridge loans designed to fill the gap between an immediate financial need and a future source of revenue.
Offering Assets as Collateral
Hard money lenders are a little bit different in how they conduct business. Instead of relying on a borrower’s ability to repay when making an approval decision, they rely on the value of certain assets the borrower puts up as collateral. In nearly every case, the lender wants a hard asset – like real estate. That is where the ‘hard’ in hard money lending comes from. I told you it was simple.
Salt Lake City’s Actium Partners, a hard money lender active in Utah, Colorado, and Idaho, explains how it all works. They say that most of their loans go to property investors. In addition, the properties said investors are hoping to obtain via hard money loans function as the collateral.
Actium Partners will take a look at the amount of money a borrower is asking for. They will also look at the borrower’s down payment and the value of the property being acquired. If that value exceeds the amount being requested, Actium can usually find a way to approve the loan. But if the value isn’t there, either the borrower will have to come up with a higher down payment or the loan will be denied.
Why Hard Assets Are Preferred
Hard money lenders are private lenders allowed by law to set their own rules, at least for the most part. That means they can accept virtually any asset as collateral. So why the preference for hard assets? Why would a lender like Actium Partners insist on real estate?
A hard asset has tangible value. It is also easily liquidated. Think about a piece of commercial property. It has inherent value simply because it is real estate. More importantly, the property can be easily liquidated in the event a borrower struggles to pay off his loan.
A softer asset may present more problems for the lender. The more difficult it is to extract value from an asset, the less valuable it is as collateral. Incidentally, this explains why conventional lending is sometimes referred to as ‘soft lending’.
A Borrower’s Ability to Repay
Where hard money loans are approved based on asset value, soft money loans are approved based on a borrower’s ability to repay. Lenders do not have valuable assets to work with as collateral. So instead, they are compelled to scrutinize every aspect of a borrower’s financial situation before approving a loan.
This explains why mortgage lenders ask for so much documentation. It is why they go through the finer details of a borrower’s credit report and history. If there is any indication that a borrower might struggle to repay, a lender gets nervous.
Even though both hard and soft money lenders take risks, the hard money lender’s risk is greater. Lenders like Actium Partners require hard assets as collateral as a way to minimize risk. That is where the ‘hard’ in hard money comes from. It is all about a borrower’s assets rather than their ability to repay. And now you know.