Hard Money Mortgages
┠What is a hard money mortgage?
┠What is a bridge loan?
┠What is a subprime loan?
┠What is the Home Ownership and Equity Protection Act, and what is its purpose?
┠What is predatory lending, and how can I avoid falling victim to it?
What is a hard money mortgage?
There are two definitions of a hard money mortgage. The first is any mortgage loan not used to purchase the mortgaged property. This definition is used for purposes of foreclosure in states that do not allow a deficiency judgment for the purchase of money mortgages. This is discussed in Chapter 20, which deals with foreclosures.
The second definition is a loan that is also referred to as a subprime or substandard loan. There is no exact definition of what makes a loan subprime or substandard. The classification of loans ranges from A loans (which are the best for the borrower) to B and C loans (usually having a 2%-3% higher interest rate than the highest rate A loan) to hard money loans. The hard money loans carry a much higher rate and higher points than B and C loans. There are variations within each category, ranging from small variations for A loans to the largest variations for hard money loans.
With the expanded use of adjustable rate loans in recent years, the subprime loan has come to be defined as any loan to a borrower with a poor credit rating, or in other words, loans to borrowers who should not be getting approved for these loans. The distinction between A, B, and C loans is now blurred. Because of the collapse of the housing market in 2007 and the high foreclosure rate of subprime mortgage loans, this is now changing back to the more traditional way mortgage loans are approved.
What is a bridge loan?
A common type of hard money mortgage loan is the bridge or gap loan. As the names imply, it is used to connect transactions (bridge) or fill a void (gap) between transactions. The following are examples of the use of these loans.
• Your home is in foreclosure. You can sell it and come out with some money, but you need time to do this. You already have a buyer and have opened escrow. You get a temporary loan to reinstate your mortgage until your sale is finalized.
• You want to buy property, but have to act immediately. You can either sell other property or arrange financing to cover the purchase, but you do not have time for either. You get a hard money loan until you can either sell or arrange suitable financing.
• You have a small business. You have an opportunity to buy inventory at a once-in-a-lifetime price. You know that you can make a large profit, but you need cash to take advantage of the deal. You get a hard money loan until you can sell off enough of the product to pay it off.
All of these loans involve the borrower mortgaging property — usually his or her home — for a short period of time. Most of these loans are for one year or less. They depend on equity for security, and the borrower's credit or income-to-debt ratios are of secondary importance. The loans fund quickly — some as fast as one week.
The up-front cost of these loans is usually one or two points, plus miscellaneous fees. The higher cost comes when the loan is repaid. This can be as high as 10% of the balance.
What is a subprime loan?
The second type of hard money loan is the subprime loan, a longer-term loan at an exceptionally high interest rate with high points and fees. The loan can be used for any purpose. It is the loan borrowers obtain when their credit or income problems disqualify them from getting a B or C loan. Chapter 23 covers these types of loans in more detail.
What is the Home Ownership and Equity Protection Act, and what is its purpose?
Not surprisingly, borrowers getting subprime loans tend to be less educated about finances and more susceptible to what is known as predatory lending practices. To protect these borrowers, the federal Home Ownership and Equity Protection Act (HOEPA) was passed. The act does not prohibit lenders from charging high rates and points, but it does require them to disclose to the borrower what is being charged and the borrower's right to refuse the loan.
The act's disclosure requirements come into play under certain conditions. The triggers, as they are called, happen when the annual percentage rate exceeds 8% above the Constant Maturity Treasury Bill index for first mortgages, and 10% for junior mortgages. A second trigger is when points and fees exceed the greater of 8% of the loan amount or $465 (adjusted annually).
Other provisions include prohibiting flipping — the practice of refinancing loans for no apparent benefit to the borrower in order to generate loan fees. The act prohibits refinancing a HOEPA loan with another HOEPA loan within one year, unless it is in the best interest of the borrower. Another significant requirement is that the lender must consider the borrower's ability to repay the loan rather than basing the loan entirely on the equity in the property. Prior to the act, many loans were made knowing that there was little chance the borrower could make the required payments. As long as the property could be sold at the foreclosure auction for enough to repay the loan, the loan was made.
There are also restrictions on balloon payments for loans of less than five years and a prohibition of arbitrary calls. This prevents the lender from demanding that you repay the loan in full, even if you have been making your payments as agreed and are not selling the property. The practice of calling the loan was used to force the borrower into an expensive refinance.
Some states have enacted laws that extend beyond HOEPA. The most significant are those that take away the holder in due course protection from secondary lenders. The buyer of a loan in the secondary market is protected from liability even if the original lender unfairly took advantage of the borrower, unless the secondary lender was aware of the practice. Some states now say that the secondary lender has the same potential liability as the originating lender. If you believe you were cheated by your original lender and your loan has been sold, consult an attorney. If there was fraud involved with the possibility of punitive damages, some lawyers will take the case on a contingency fee basis, which means they only get paid if you win your case.
The argument against restrictions of hard money mortgages is that they take away the ability to borrow from those who need the money most. In order to prevent this, laws like HOEPA are designed to cover only the most egregious practices. A Federal Reserve study estimates that only about 5% of hard money loans fall under the protection of HOEPA.