Hard-Money Loans Can Lead Borrower to Harder Times

Bankruptcy? Foreclosure? Bad credit? How about no job?

All these misfortunes are no problem. At least that’s the impression you’ll get by looking at newspaper ads for so-called hard-money loans.

These hard-money lenders make real estate loans that most conventional lenders wouldn’t even think of touching. But there’s a catch. Borrowers who have equity in their home had better be ready for 14% to 18% mortgage rates, as many as 15 loan origination points and plenty of other fees and potential penalties.

You’d think that the term hard money comes from the hard terms offered to hard-up borrowers. But hard money refers to the fact that these loans are financed by investor cash vs. “soft-money” bank loans. Today’s hard-money lenders prefer to be called “equity lenders.”

But borrowers must take care when considering such loans. Just ask Loretta Lee.

Lee took out a third deed of trust on her modest three-bedroom home about two years ago. She’s retired and doesn’t have much income, plus she has two other mortgages, so a conventional loan was pretty much inaccessible. To pay off some of her son’s debts, she consented to a loan with an interest rate exceeding 16%. The home that she’s owned for 19 years is now facing foreclosure, with a notice of default filed in July by Action Home Loan Corp. in Los Angeles.

Lee and her son fell behind on two $231-a-month payments. They must either work out a deal with their lender now or face a trustee sale. Lee said her lender is demanding the full balance of the loan--about $7,400 plus penalties. Albert M. Gentile, co-owner of Action Home Loan said, however, that he’s willing to work out a payment plan with Lee.

“We’re not here making loans to little old ladies to steal their houses,” Gentile said. “She’s welcome to come down here and talk to us.” Action would prefer not to proceed with foreclosure, Gentile said, “but we can’t just look the other way and hope that the payments are made.”

Lee isn’t alone in her predicament. There are homeowners throughout the San Fernando Valley who have equity in their homes but not enough good credit to get a conventional mortgage.

“We are the lender of last resort,” said Ted Kolchier, senior loan officer at Zenith Home Loan Inc. in North Hollywood. People come to Zenith for a variety of reasons, he said. Some borrowers need money on very short notice. Some have bad credit and don’t qualify for anything else. Still others have so-called non-conforming properties--such as a building that combines retail uses with a residence--that most lenders won’t accept as security on a loan.

“If it’s obvious that they can’t pay out of their income, we’ll sometimes insist that funds be held in a trust account,” Kolchier said. That, of course, adds even more costs to loans that are already in the 15% range.

And why so expensive? Kolchier said that finding investors for these loans is like finding buyers for junk bonds. Most investors don’t want to risk their money on questionable deeds of trust. Those investors who are willing to take the risk want a high rate of return, he explained.

Interest rates on most mortgages have come done markedly in the past few years. But hard-money loans are only about 2 percentage points lower than they were in 1988, said Stanley Gainsforth, a principal of London Financial Assn. in Woodland Hills and a columnist for a lender publication called Mortgage Market Weekly.

The only good news, he said, is that “hard money is being replaced by somewhat more conventional products.” London offers 30-year mortgages with an adjustable rate starting at 9.75%. There’s a lifetime cap of 15.75% and an upfront fee of about three to four points. This isn’t exactly cheap, but for people who are facing foreclosure or a bankruptcy, Gainsforth said, “it’s the way to get out of a corner.”

Even hard-money lenders have their limits as to who will qualify for a loan, however. “I’m not interested in arranging a loan for a hopeless case,” Gainsforth said. “In today’s marketplace, there is no real loan available for someone at the end of the line; they really need to sell.”

Contrary to conventional wisdom, he maintained, most hard-money lenders don’t want to foreclose on their loans. “Most lenders don’t want the property back, they want a secured investment,” he said. Besides, if lender B forecloses on a second deed of trust, that lender still has to keep up the payments on lender A’s first deed of trust to avoid foreclosure by lender A.

While most hard-money lenders may not be interested in lending to the weakest borrowers, there are some slick operators who seek out injured borrowers like a carnivore seeks prey, said Earl Peattie, president of Mortgage News Co., a Santa Ana firm that monitors interest rates. “A lot of hard-money lenders take advantage of people in a horrible way,” he said. Some lenders look for borrowers who are almost sure to default.

“Knowledge is power. The more you know the better you can pick and choose,” Peattie said. “See what your deficiencies are before you apply for a hard-money loan,” he added. “Many people will qualify for conventional loans and they don’t even know it.”

Ask questions and check out your lender thoroughly, advised Richard Pittman, a former hard-money lender and now director of counseling at the nonprofit Consumer Credit Counseling Service. The organization offers free counseling to the public and has offices in North Hollywood and Burbank. The number to call is (213) 368-4550. There’s also a CCCS in Ventura at (805) 644-1500.

Pittman also recommends that would-be borrowers call the Department of Real Estate to inquire whether a lender is properly licensed and to check if there have been any complaints filed about the lender with the DRE. The number is (213) 897-8001.