5 underwriting criteria to determine the viability of a Hard Money Loan Scenario


Every year, NFL executives, scouts, coaches, and analysts fly to college football games, scour videos, and scrutinize statistical reports about potential draft selections.  The NFL conducts the Combine where NFL prospects try out in front of representatives from the 32 NFL teams.  Production, Height-Weight-Speed, Durability, and Intangibles are all weighed and analyzed.  The number crunching and analysis culminates at the NFL Draft where these NFL Owners choose the best and most needed player for their team’s specific needs.

Like an NFL owner evaluating height, weight, and speed to determine a draft selection, Hard Money Lenders use underwriting criteria to weed out loan scenarios.  Hard Money Lenders receive many calls and emails with varying loan scenarios.  Some scenarios are dead on arrival and some “make the cut”.  What are the primary success factors that determine whether a hard money loan scenario becomes a funded loan?

  1. Equity Protection: Number one is equity protection. Hard money loans are typically based on the equity in the property and not on the Credit Score or income of the borrower.  Equity protection is the difference between the loan amount and the value of the property.   Capital Preservation remains a key for lenders investing in hard money loans and the equity protection or “equity cushion” provides room when a problem occurs with the borrower or property.  Equity can erode quickly in a foreclosure or distress scenario.  Elevated Loan to Value ratios threaten equity protection and should be carefully analyze before being accepted.   Equity protection, which could be equity in the property on a refinance or a down payment on a purchase transaction, typically implies the borrower having “skin in the game”.   Skin in the game incentivizes the borrower to keep the loan current and exit the loan appropriately.
  2. Exit Strategy:  Most Hard Money loans have a 1-5-year duration.  How will the borrower exit the loan at loan maturity?  Through a conventional refinance? How will the borrower get a conventional loan in the future when they cannot get one now? If selling the property is the exit, the question is will the property be sellable? What is the timeframe to sell? What is the market value? All the answers to these questions need to be realistic assumptions.
  3. Borrower Character: What is the borrowers character and the ability to execute on the loan commitment?  Is the borrower litigious? Does the borrower have history of successful payments or a history of asking for loan modifications?  Is Chain of Title on the property sufficient to allow the borrower or entity to sign for a new encumbrance?  Is the borrower’s story about the property acquisition, history and why they need the loan viable?  Loans can be mutually beneficial until a problem arises and then a borrower’s character will determine their ability to work through payment or property issues should they arise.
  4. Loan Purpose and Occupancy: Is the loan for a Consumer or Business Purpose? Is the property owner occupied or non-owner-occupied? Different laws and statutes apply when dealing with loan purpose and occupancy. To stay compliant, the loan purpose and occupancy must be clearly defined and documented.
  5. Ability to Pay/Repay: Where will the monthly mortgage payment come from? Does the borrower have the monthly income to make the payments? Do the bank statements show the velocity to afford the payment? Does the rental income cover the nut? While Hard Money Ability to Pay/Repay (ATR) requirements are not as defined and stringent as in the conventional lending world, the ATR should be used to ensure proper loan structuring and repayment.  The Ability to Pay criteria can be satisfied through interest reserves, income, rents, asset depletion, cash in the bank but not a hope and a prayer or a lottery ticket.

Draft selections will make or break NFL teams this year.  Hard Money loan underwriting decisions will do the same for Lenders.