[Editor’s note: This is a guest post from Matt Rodak, CEO of Fund That Flip, an online lender that provides short-term loans to experienced residential real estate redevelopers. Accredited Investors can invest online in loans originated by Fund That Flip. Annual yields range from 9-12% over 6-12 month terms. Fund That Flip was a 2017 Lendit Industry Awards Finalist. You can learn more at www.fundthatflip.com/lender. Matt can be reached at Matt@fundthatflip.com.]
Hard Money Lending: A Quick Intro
Back in 2012, I borrowed money to purchase a house I planned to fix-and-flip. I contributed 20% of the purchase price as a down payment. For the privilege of borrowing the other 80%, I paid a local “hard money lender” a 3.5% origination fee plus interest only payments at a 13% APR.
At the time, I was also an avid reader of LendAcademy and doing a bit of investing on the “peer-to-peer” lending platforms. I was averaging a 10-11% return on the platforms and I remember thinking:
“Why am I paying 16.5%+ for a first-lien loan that’s secured with real estate while receiving an 11% return on an unsecured consumer loan? This makes no sense. This “hard money” market is not operating efficiently.”
I started doing some more research into the market that was originating a majority of these types of fix-and-flip loans, which is called “hard money lending”. There were a few things that became quickly apparent to me.
1. The market was highly-fragmented. There wasn’t a single lender that controlled any significant amount of the national market. More specifically, I couldn’t find a lender that had more than 1% of the overall market. There were a handful of larger lenders that operated in multiple States, but for the most part, this was a market made up of numerous small, local lenders.
2. The use of technology was virtually non-existent. The ability to apply online for a hard money loan didn’t exist. The lender I borrowed from didn’t even have a website. Even the larger lenders I discovered, were mostly operating via email, PDF loan applications and “boots-on-ground” underwriting.
3. Capital formation was very analog. The balance sheets of these hard money lenders were often made up of a few high-net-worth individuals and some additionally sourced “country club” capital. This put them in a perpetual cycle of originating new loans to keep their funds working while also raising additional capital to meet the demands of their borrower base. Too much cash was a drag on returns while not enough would cause them to pass on loans they’d otherwise originate.
4. Hard Money Lenders, generally speaking, had a very negative reputation among the borrower community. This was in part due to the high interest rates. However, upon further digging, the real cause of dissatisfaction among borrowers was the lack of service and transparency. I heard stories of lenders not showing up with funds at closing, leaving the borrower at risk of losing their deposits. Other stories involved undisclosed fees that were charged when borrowers made requests for construction funds. More innocuous offenses included lack of responses to funding requests; long-form loan applications that had to be handwritten; repeated requests for information that had already been provided; and numerous other customer service follies. [Read more…]