The impact of a rising interest rate environment on hard money loans

August 2018 Published by Leave your thoughts

Hard money loans are short-term, interest-only mortgages used by investors to purchase and rehab distressed properties. These loans have higher rates up to 12% but can fund in 15 days, helping investors compete with all-cash buyers. The loan is generally paid back within 12 months when the property is flipped or when permanent financing is obtained.

Collateral types for hard money loans continue to expand beyond single-family residences. The allure of multifamily, commercial properties, senior housing, self-storage, and other sectors is growing. The breadth of opportunities exists for hard money investors and borrowers alike. This source of investment capital continues to grow and be a reliable source of capital funding key investments for credit-impaired borrowers or those seeking a swift financing solution without relying on the lengthy credit underwriting analysis of borrower credit worthiness and collateral as is practice of banks that oftentimes does not meet investor closing time requirements.

The demand for lending alternatives continues to grow and the supply of funding options is migrating to meet that need. The key is having a financing source that moves quickly, executes efficiently and operates in an accommodating manner. Respected hard money lenders have proven their ability to meet these needs.

In terms of outlook on interest and its impact on the availability of hard money loans, t    he last rate hike in June 2018 took rates from 1.75 percent to 2 percent, and the Fed have generally demonstrated support for two more rate hikes before the end of the year. Generally speaking, the lower interest rates are, the easier it is for the economy to grow. But when the economy grows too fast, it can overheat and create the sort of bubbles and subsequent crashes that can undermine long-term growth — like the 2008 financial crisis.

How might an increase in interest rates impact on hard money lending activity?

Firstly, Interest rates are typically set on a case by case basis and are impacted by the specifics of the deal, not by changing government regulations as conventional loans are prone to. Borrowers seeking a reliable capital source with less stringent evaluation criteria, working with private lenders is a smart option.

Borrowers of investment properties may find greater opportunities in sourcing opportunities at more attractive pricing due to cap rates rising (an inverse to value). This may result in an ability to source debt capital at higher Loan-to-Value metrics all else equal.

Hard money loans are likely to maintain their existing range of pricing in a rising interest rate environment due to the level of sector competition, thus reducing the differential on pricing over confirming mortgages. This is likely to drive more cost-sensitive borrowers to hard money loan options based on greater flexibility.

Traditional lenders oftentimes underwrite borrowers based on the borrower’s global debt service to cash flow metrics. To the extent that a perennial borrower of debt has a large share of floating rate-based debt, this may stress debt service calculations and drive borrower interest to hard money options.

In an increasing interest rate environment, floating rate debt products provide borrowers with a hedge against fixed pricing risk. Hard money loan options are likely to provide predictability to borrowers by maintaining their fixed rate features.

Overall, a rising interest rate environment is likely to inure to the benefit of hard money lending activity. Underwriting standards need to be maintained to ensure sufficient pricing justifies the risk assessment, yet hard money loan activity should continue to grow its share of activity in a rising interest rate environment, demonstrating a reliable and growing avenue of debt capital for borrowers of investment real estate.

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