By MICHAEL KITCH, LACONIA DAILY SUN
LACONIA — "Hard money" lending, which was tainted by the collapse of Financial Resources Mortgage Inc. in 2009, has gathered momentum as banks, coping with changing regulations, have retrained construction lending and investors, chaffing at low yields, are chasing higher returns.
Hard-money loans are short-term instruments secured by the value of real property generally used by developers or owners of real estate to finance the construction or renovation of property in anticipation of selling it for a profit. Sometimes called loans of "last resort" or "bridge loans," hard-money loans are issued by private investors and small companies rather than conventional financial institutions like banks.
Although lenders may consider the creditworthiness of the borrower, their decision to make a loan and in what amount is primarily based on the value of the property collateralizing it. To lessen the risk to the lender, most finance in the first lien position, ensuring they are the first creditors to be repaid in the event of default. Likewise, hard-money loans carry a lower loan-to-value ratio than conventional bank financing; that is, a lender would advance up to 75 percent of the value of the property securing the loan. Finally, hard-money loans carry relatively high interest rates, as many as 10 points higher than conventional loans, as well as origination fees and closing costs.
A hard-money lender stressed that the current practice bears no similarity to the Ponzi scheme operated by Financial Resources Mortgage Inc., which solicited investors, pooled or comingled their investments and allocated the money to different borrowers. When borrowers defaulted and income shrank, one round of investors were paid with investments of another round of investors until the money ran out.
Currently, the lender said that lenders and borrowers enter one-to-one relationships in which each party is represented by an attorney. "The closing is done just like a bank," he said. "We don't take money from investors, but only lend our own money. It's private lending." He said there is an informal network, connected "by word of mouth."
Although borrowers, lenders and bankers were unwilling to speak on the record, all agreed that that any increase in hard-money lending reflects a tightening of credit by banks. One longtime home builder with a sound track record said flatly "The banks aren't making construction loans." He was echoed by an individual who said that as banks have grown reluctant to lend "all kinds of people are loaning out money."
Bankers acknowledged that a new rule, issued by the Consumer Financial Protection Bureau in the wake of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, has crimped construction lending in particular. The rule, known as "TRID," a train wreck of federal acronyms compounding the Truth in Lending Act (TILA) and Real Estate Settlement Procedures Act (RESPA) to make TILA-RESPA Integrated Disclosure or TRID. Introduced in October 2015, the rule is intended improve understanding of the mortgage process on the part of consumers as well as assist them in comparison shopping and spare them surprises at closing.
However, as one banker explained, the Consumer Financial Protection Bureau offered no guidance on applying the new rule to adjustable rate construction loans. He said that software is still being developed to automate the process and in the meantime the managing the paperwork manually adding to the time and cost originating and closing loans.
A survey of 548 banks undertaken by the American Bankers Association in May found that three-quarters reported that TRID caused delays of up to 20 days in closing loans. Nearly as many reported that software vendors had yet to overcome glitches in their systems. A quarter of banks reported suspending products, with construction loans, especially those that convert to permanent financing, among the most likely to be shelved.
A local banker anticipated that the problems arising from TRID will soon be overcome and banks that have suspended construction lending will be re-entering the market.
Apart from TRID, one banker suggested that the cost of constructing a new home often exceeds its appraised value, which is based not only on the cost of building it but also on the selling prices of similar homes nearby. Homes are appraised after the builder and buyer agree to a purchase price. If the purchase price exceeds the appraised value, the buyer will have trouble securing a mortgage, putting the transaction at risk. This scenario was especially prevalent during the recent recession when there was a glut of foreclosures and short sales on the market. Although the market has revived, the banker said that some conventional construction lending may be stymied simply because the transaction founders on the difference between construction costs and appraised value.