Hard money loans tend to be significantly more expensive than a traditional loan, often with interest rates in the range of 12% to 20% with relatively high upfront costs. In addition, the owner is usually a private individual with substantial wealth and requires collateral in the form of real estate. Hard money loans aren’t all bad as they can be a way for someone who cannot obtain traditional financing to have the means to purchase real estate.
What Is a Hard Money Loan?
A hard money loan is a short-term loan used by investors to access funds to purchase properties quickly. Often, hard money is used to buy a property that might typically be avoided by a bank or lending institution, such as a distressed property or one you intend to fix up and flip for a profit. The idea is that the property will be resold quickly enough that the fees and excessive interest won’t be as much of an issue.
If you’ve already engaged in real estate investments, you may be familiar with how hard money loans work. However, if you’re new to the game, the main thing that hard money lenders look at is the asset’s value. This means that you usually don’t need to have appraisals, personal financial statements, or a credit check.
Consequences of Defaulting on a Hard Money Loan
No matter what kind of loan you have, if you default, that leads to extreme stress and should be avoided at any cost. However, life doesn’t always work out the way you want it to, so what happens if you default? Inevitably, defaulting on a hard money loan will lead to your property being foreclosed. The bank will either take possession of the property or sell it at auction.
Most real estate investors know the rules and regulations regarding the foreclosure process for conventional or FHA loans on an owner-occupied home spans pages and pages of loan documents. However, with a hard money loan, the parameters for defaulting are delineated in the closing documents. Non-payment or breach of contract is typically the baseline default condition.
Does Default Immediately Cause Foreclosure?
The short answer is no. The foreclosure proceedings do not start immediately. Typically, the loan documents, in addition to delineating the default terms, also discuss the remedy methods. Examples of this would include making up for any missed payments and overdue balances along with fees and other costs. A typical example is giving a borrower 30 days to make up the lost payments prior to foreclosure.
Once the remedy time has expired without action and the property enters into default, other stipulations will become active as described in the loan documents. These stipulations would include a default rate and any additional fees or penalties. For example, if the documentation establishes a default rate of 30% and a 15% late fee based on the monthly payment, that would lead to your monthly payments increasing until the borrower has remedied the default or alternative financing has been procured.
However, foreclosure is inevitable if the borrower cannot make any payments. The process for foreclosure may depend on local regulations and methods used to record the property. One important distinction to make is if the state you’re in is a deed of trust state or a mortgagee state. Deed of trust states don’t require legal proceedings in order to foreclose. Instead, they use a nonjudicial foreclosure. Meanwhile, mortgagee states require legal proceedings in order to carry out the foreclosure process.
What Happens to Your Equity in a Foreclosure?
Even in a foreclosure, whatever equity is in the property stays with the property. In that case, once the property sells, the lender can only keep the amount of proceeds that equals what they are owed plus any fees and other costs associated with the foreclosure process. Any leftover proceeds from the sale, after foreclosure and any other liens related to the property are paid off, will go to the borrower.
Two main variable factors determine how much the borrower will get back from the foreclosure proceedings. If multiple loans and liens are taken out against the property, they must be paid as well prior to any proceeds being returned to the borrower. The property selling price would be the other obvious determining factor on what the borrower can expect to receive after the sale of the foreclosed property.
However, there are a couple of caveats to consider that can mitigate the return you receive. First of all, the increased payment amount will continue to decrease the amount of equity in the property. Also, when a property is sold at auction, it’s typically below market value, often significantly so.
For mortgagee states, the borrower has to be notified of default before the lender files a foreclosure claim. Once the suit has been filed, the lender must also inform the borrower of that fact as well. Then the regular legal proceedings will occur, which can take up to a year. However, in a deed of trust state, a nonjudicial foreclosure only takes weeks, and often the only notification you get is when the lender informs you of the upcoming sale date.
Unfortunately, the loss of your property and the legal proceedings do not necessarily mean your troubles are over. Having a foreclosure on your credit report will lower your credit score significantly, in the range of 85 to 160 points, depending on your credit profile strength. If your rationale for taking the hard money loan was due to credit woes, the foreclosure would exacerbate the credit problem. In a worst-case scenario, if the sale didn’t cover the total amount of what was owed, the lender may be able to sue for the remaining balance, depending on the state.
Titan Funding offers hard money loans to qualified borrowers. If you’d like more information on the application process, interest rates, terms, or anything else concerning a hard money loan, reach out to one of the professionals at Titan Funding. You can reach us at 855-910-6434 or via our convenient online messaging system. We would be happy to answer any questions you may have or get you set up for an application.