Do Hard Money Lenders Utilize LTVs the Same as Banks?

Hard money lenders offer a valuable service to borrowers who would rather not rely on conventional financing. Some of what they do is remarkably different compared to commercial banks. But some of the things they do are quite similar. Take loan-to-value (LTV) ratios, for example. Hard money lenders utilize them. An LTV is a ratio that compares the value of a property against the amount of money a lender is willing to loan. A simple example illustrates the point. Say you have a piece of property valued at $500,000 and an LTV of 50%. The lender would only be willing to loan a buyer $250,000 to purchase.

LTVs Protect Lenders to Some Degree

Lending in any form is a risky venture. Some types of loans are riskier than others, and that forces lenders to utilize extra tools to protect themselves. The LTV is one such tool. It protects lenders, at least to some degree, against sizable losses when loans are not paid. Lower LTVs also tend to weed out borrowers who do not really have the financial resources to borrow safely. Hard money lenders tend to have lower LTVs compared to banks. They require that borrowers bring more money to the table. Why? Because requiring higher down payments shifts more risk to the borrower. The greater the borrower’s risk, the less likely that someone without sufficient financial resources will end up taking out an unaffordable loan.

What It Means to Borrowers

The LTV principle is pretty simple to understand. From the borrower’s perspective, it is about making sure one has enough money to put down a sizable down payment. The one difference between hard money LTVs as compared to how banks and credit unions operate is the fact that hard money lenders generally don’t care where the down payment comes from. Where conventional lenders frown upon the idea of coming up with a down payment from any other source than the borrower’s own funds, hard money lenders generally don’t care as long as they maintain the first position on the borrower’s assets. To illustrate this point, consider a borrower looking to score a hard money loan to buy an investment property.

First Position on the Property

The property being obtained acts as collateral for the loan. For as long as the loan is outstanding, the hardly lender maintains a lien on it. Being in the first position means that the lender is the first to receive sales proceeds should the property be seized and sold due to loan default. Salt Lake City’s Actium Partners says that hard money lenders rarely agree to taking second or third position, if ever. Hard money lending is risky to begin with. Not being in the first position only makes things worse for lenders. So with hard money, it’s first position or nothing.

Investors Should Plan on Half

Hard money lenders are free to set their own LTVs as they see fit. There is no ‘typical’ LTV. The general rule of thumb for investors is to plan on 50%. If an investor can find a lender with a higher LTV, it is considered a bonus. Sticking with 50% is the easiest way to ensure a borrower will have enough for a down payment. Both parties only put in half. The LTV is a tool designed to protect lenders. Retail banks and credit unions utilize LTVs all the time. So do hard money lenders. It is a tool that forces borrowers to put some of their own money into the deal. Otherwise, they risk nothing. That means they have less incentive to make good on their loans.