Hard money. It just has a certain ring to it,
doesn't it? It really does. I have to be honest,
when I first saw this was our topic for today's
deep dive, my mind did not go to, you know, legitimate
finance. Oh, where did it go? Straight to a noir
film. I'm talking like a rainy Chicago alleyway,
maybe 1940s. There's a guy in a trench coat,
fedora pulled down low. That's cigarette, definitely.
Oh, absolutely. A cigarette dangling from his
lip. And there's a suitcase full of Cash non
-sequential bills, of course, being slid across
a wet table. That is a remarkably vivid picture
and a very common reaction. It just sounds so
intense, maybe a little illegal. You know, if
I'm asking for hard money, it feels like I've
run out of all other options. Like you've burned
every other bridge in town. Exactly. It sounds
like the kind of money that. comes with a very
specific very physical repayment plan if you
miss a payment you're talking about broken kneecaps
i didn't want to say it but yeah my imaginary
version of this definitely involves kneecaps
being at risk well i can assure you and everyone
listening that we are not here to discuss organized
crime or loan sharking today okay good while
the name is gritty and frankly the industry knows
it has a massive branding problem what we're
actually talking about is a legitimate pretty
sophisticated and an absolutely critical corner
of the financial world, especially in North America.
So it's a real financial instrument. It's a financing
instrument that keeps a huge, huge portion of
the real estate market moving. So I should probably
put the trench coat away. I would put the trench
coat away. But keep the skepticism because this
is a world that operates on a completely different
set of rules than your local neighborhood bank.
That's what I want to dig into. Because looking
at our research stack here, and we've got a lot
from trade group resolution, to, you know, federal
regulatory history. It feels like a parallel
universe to traditional banking. That's a perfect
way to put it. For a long time, it was basically
a shadow banking system. So what's our mission
today, then? We've got to decode this whole world.
If it's not illegal, why the scary name? And
the big one for me, the thing that just jumped
off the page. Let me guess. The interest rates.
The interest rates. Why are smart, rational...
business people willing to pay double digit interest
rates for this money. That's the central mystery,
isn't it? Why pay 12, 13, 14 percent interest
when a bank is charging, what, 7 percent right
now? Right. We're going to unravel that. We're
going to get into the mechanics of risk and collateral.
But I think the most fascinating piece of this
puzzle is how the global financial crisis of
2009. The big one. The big crash inadvertently
poured gasoline on this entire industry. I love
when we can trace things back to 08 or 09. It
really does feel like the big bang of modern
finance. Every time we peel back a layer on the
economy, there's a route that goes right back
to the housing bubble or Dodd -Frank. It completely
reshaped the plumbing of the global financial
system. And hard money is one of the things that
grew very quickly out of the rubble. OK, so let's
set the vibe for everyone listening. If we're
not in that rainy back alley, where are we? What's
the scene? OK. I want you to imagine you're a
real estate investor, not a homeowner looking
for a place to raise a family. You're a business
person. You're driving down a street in your
city and you see that house. Oh, we all know
that house. You know the one. The grass is three
feet tall. There's plywood over a couple of windows.
Maybe a big tree limb has crashed through the
porch roof and nobody's moved it for six months.
It's an eyesore. The neighbors hate it. The city
has probably slapped a condemnation notice on
the front door. It's the zombie house. The zombie
house, exactly. Now most people... They just
drive past that and they see a disaster, a problem.
But you, the investor, you stop. You look at
the bones of the house, the structure. You know
the neighborhood's getting better. Prices are
going up. You see potential. You see potential.
And you do some quick math in your head. You
think, OK, if I could buy this wreck for, say,
$100 ,000 and I put $50 ,000 of work into it,
I bet I could sell it for $250 ,000. OK, I'm
with you. That's $100 ,000. profit margin just
sitting there rotting away it's a gold mine disguised
as a total dump but here's your problem you need
the cash now why now maybe it's a foreclosure
auction that's happening on friday or maybe the
owner is just desperate and they say look the
first person who shows up with a certified check
gets the keys so okay simple i go to my bank
right i walk into the branch with the free lollipops
and the pens chained to the counter. I sit down
with the loan officer and I say, Hi, I found
a fantastic deal. I need $100 ,000 by Friday
to buy a house with a giant hole in the roof.
And what do you think that loan officer does?
They laugh at me. They look at you, they look
at the picture of the house with the hole in
the roof, and they very politely ask security
to show you the door. They won't touch it. No
way. Yeah. Traditional banks, they generally
cannot lend on properties that are considered
uninhabitable. They have these strict checklists.
The roof has to work. The plumbing has to be
functional. And even if the house was in perfect
condition. They're slow. They move at the speed
of a glacier. You're looking at 45, maybe 60
days to get a loan approved. And by that time.
The deal is long gone. Someone else bought it
for cash a month and a half ago. So you're stuck.
You found this guaranteed profit, but you can't
access the capital to actually unlock it. And
that is the moment hard money walks in the door.
That is exactly where our story begins. All right,
let's unpack this. We have to start with the
definition because I think hard money is one
of those terms people just throw around. What
makes the money hard? Is it hard to get? hard
to pay back. That's a really common misconception.
People hear hard and they immediately think difficult.
But in this context, hard actually refers to
the hard asset. OK, the physical thing, the property.
Exactly. It is a very specific type of asset
based lending. And to really get it, you have
to compare it to how a normal loan works. Think
about when you got a mortgage for your house
or even just a credit card. What did the bank
want from you? Oh, everything. They wanted my
pay stubs, my W -2s, my tax returns for the last
two years. They ran my credit score. They probably
called my boss to make sure I still had a job.
Right. They were underwriting you. They were
looking at your soft data, your character, your
reliability, your income stream. The bank is
betting on the person. They want to be sure that
you personally are good for the money. Which
makes sense. They want to get paid back. Of course.
But in a hard money loan, the lender is... I
mean, sometimes almost exclusively looking at
the thing. The house. The hard asset, the real
property. So the borrower gets funds that are
secured by that property. The hard asset is the
ultimate backstop for the whole deal. So they
don't really care about me, my credit score and
all that. They care a little bit. You know, they
want to know you're not a known fraudster or
something. But they care mostly about the building.
Their internal logic is basically this. I don't
really care if this borrower lost their job last
month. I don't really care if their credit score
is a 600. What I care about is if they stop paying
me, can I take this house, sell it, and get all
my money back plus profit? So the building itself
is the cosigner on the loan. The bricks and mortar
are doing all the heavy lifting in the approval
process. That is a perfect way to put it. It
is collateral -centric lending. But, and this
is the key. Because the lender is relying so
heavily on the asset and often ignoring those
soft metrics like a perfect credit score, the
whole risk profile changes. And because the risk
is higher. The terms have to look very, very
different. And this is where we get to the numbers
that make people's eyes pop. I really want to
talk about the cost of this money. It is not
cheap. That's for sure. The sources we have mention
interest rates starting around, what, 8 % or
9 % on the absolute low end. Much more commonly
sitting at 12%, 13%, even 14 % or higher. Yes.
Double -digit interest is the norm in this industry.
And then there are points on top of that. Yes,
points, which are basically origination fees.
Usually a hard money lender will charge anywhere
from two to four points right up front, and one
point is just 1 % of the loan amount. Okay, so
if I'm borrowing $100 ,000, I might have to pay
$3 ,000 or $4 ,000 right out of the gate just
to open the loan. Correct, before you've even
made your first interest payment. Wow. So you've
got the 14 % interest. Plus legal fees. Plus
processing fees, appraisal fees. This sounds,
I mean, honestly, it sounds extortionate. If
I'm a business owner, why would I ever agree
to this? It really sounds like I'm being taken
advantage of. It does sound that way. But only
if you're comparing it to, say, a 30 -year home
mortgage. You have to remember the duration of
these loans. Right. You're not taking out a hard
money loan for 30 years. No. God, no. You'd be
bankrupt. These are incredibly short term. We
are talking six months, 12 months, maybe 24 months
on the long end. It's a sprint. It is a sprint.
It's designed to be a bridge. You get in, you
use the money to fix the property, you sell it,
or you refinance into a cheaper long -term loan
and you get out. You pay that hard money loan
off as fast as humanly possible. So you're not
actually paying 14 % interest for a decade. You're
paying it for maybe six or eight months while
you do the work. Exactly. You have to think of
it as a convenience fee for getting access to
that capital so quickly when no one else would
give it to you. That's a good frame. Now, I noticed
something interesting in the research about the
geography of all this. The sources mentioned
that this term hard money and this whole style
of lending, it's almost exclusively a North American
thing. It is, yeah. You find it almost exclusively
in the United States and Canada. Why is that?
Why don't they have hard money lenders in London
or Paris or Tokyo? I mean... There are private
lenders everywhere in the world, of course. But
this specific systematized industry of hard money
for real estate flipping and distressed assets
is very much a product of the U .S. and Canadian
legal and economic ecosystem. And it comes down
to the laws. It comes down to foreclosure law,
really. In the U .S., generally speaking, if
you don't pay your mortgage, the lender has a
relatively clear, defined, and most importantly,
fast legal path to take that property back and
sell it to get their money. So our system is
pretty lender friendly. It's relatively lender
friendly, yes. In a lot of European countries,
for example, tenant protections and borrower
protections are much, much stronger. It can take
years, I mean literally years, to foreclose on
a property. Ah, I see. So if I'm a lender in...
say, France, I can't really lend based on the
hard asset because I might never actually be
able to get my hands on it if the borrower defaults.
You've got it. If your collateral is going to
be locked up in legal purgatory for five years,
your entire asset -based model just completely
falls apart. The liquidity of the U .S. real
estate market is what allows this industry to
even exist. It has a very, I don't know, cowboy
capitalism feel to it. Like, I need money to
build this saloon. Here's the deed to my land.
Now give me the cash. There is a bit of that
frontier spirit to it, for sure. It's all about
speed and opportunity, and it's completely separate
from the slow bureaucratic machinery of traditional
banking. OK, so we know what it is. It's asset
based. It's expensive. It's short term. But I
want to circle back to the why. We use the zombie
house example, but let's really drill down on.
the borrower's motivation because paying 14 interest
plus points still stings it does sting but let's
look at the alternative if you have that zombie
house deal the one with the guaranteed hundred
thousand dollar profit margin and you can't get
the money from a bank what's your profit it's
zero i lose the deal right so the choice isn't
between a cheap loan and an expensive loan the
choice is between an expensive loan and no loan
at all so would you rather have a hundred percent
of zero or would you rather pay a lender say
$15 ,000 in interest and fees and walk away with
$85 ,000 in your pocket. When you put it like
that, it's a no -brainer. It's just a cost of
doing business. For an investor, it's a line
item on a spreadsheet. It's like buying lumber
or drywall. You don't complain that lumber costs
money. You just need it to build the house. Hard
money is just another raw material. So the two
main drivers seem to be speed and flexibility.
Let's talk about speed first. How much faster
are we really talking here? We touched on it,
but it's worth hammering home. A typical bank
loan is going to take you 45 to 60 days, best
case scenario. Right. A hard money loan can fund
in 7 to 10 days. I've seen them close in 48 hours.
That is lightning fast. It's unbelievable. And
in a competitive real estate market, that speed
is currency. If you're bidding against five other
investors for that same property, being able
to go to the seller and say, I can close in one
week all cash because hard money is treated as
cash, that often gets you a discount on the purchase
price. Oh, that's a great point. So the speed
itself can actually save you money on the acquisition.
Very often, yes. You might end up paying 14 %
interest, but you got the house for $10 ,000
less than the other guy because you could close
in a week. It all balances out in the end. Okay.
And then there's flexibility. This is the documentation
part you mentioned. Right. The dreaded checklist.
Banks live and die by the checklist. And if you're
self -employed, if you have irregular income,
if you're a freelancer, if your income comes
from 10 different projects, banks hate you. I
feel that on a personal level. A lot of people
do. You could be making fantastic money, but
if it doesn't show up neatly on a W -2 form from
a single employer every two weeks, the bank's
algorithm just sees you as a huge risk. So how
are hard money lenders different? They're often
private individuals or small local funds. They
can use common sense. They can sit across a table
from you and say, OK, I see your tax return is
a mess, but I also see you have a ton of cash
in the bank and this house you found is a grand
slam deal. Let's do it. There's no corporate
headquarters in New York City telling them no.
Exactly. They can underwrite the story of the
deal, not just the borrower's HICO score. Now,
I want to clarify something here because the
research brings up bridge loans constantly. And
it feels like people use these terms, hard money
and bridge loan, interchangeably. Are they the
same thing? They are cousins, very close cousins,
maybe even siblings. They share a ton of DNA.
A hard money loan is very similar to a bridge
loan in terms of the lending criteria and the
costs to the borrower. Are both short term, asset
based. Higher interest. Correct. But there is
a bit of a nuance, a vibe shift, if you will.
A vibe shift. Yeah. A bridge loan usually sounds
a bit more. polished, a little more corporate.
It often refers to a commercial property or an
investment property that's just in a state of
transition. OK, give me an example of that. Let's
say you buy a small apartment building. It's
in decent shape, but it's only 50 percent full
because the last owner was lazy and didn't market
the empty units. Right. A regular bank won't
give you a standard commercial loan on that building
because the income isn't high enough yet. It
doesn't cash flow properly. So you're stuck.
You need a bridge. You get a bridge loan for
12 or 18 months. You use that money to do some
light renovations on the empty units. You hire
a leasing agent. You get the building to 95 percent
occupancy. Now the building is stabilized and
making great money. And then you go to the bank.
Then you go to a regular bank. You get a cheap
30 year loan and you use that to pay off the
expensive bridge loan. You've successfully bridged
the gap from instability to stability. That makes
perfect sense. Bridge loans are for properties
in transition. Yeah. So what makes hard money
different? What's its vibe? The distress factor.
Hard money, as a term, often implies a situation
that is a little more dire, a little grittier.
OK, here comes the drama. This is where we get
into the historical roots of the industry. Hard
money isn't just an asset -based loan for a simple
transition. It often involves a distressed financial
situation. Like what? Like being in arrears on
an existing mortgage. So the borrower is already
behind on their payments to another bank. Exactly.
Or they're in the middle of bankruptcy proceedings.
Or, most commonly, they are facing active foreclosure
proceedings. Wow. Okay, so if I'm in foreclosure,
a traditional bank won't touch me with a 50 -foot
pole. They will run in the other direction. A
traditional bank sees a foreclosure notice, and
they see a four -alarm fire. A hard money lender
sees a foreclosure notice, and they see equity.
Explain that. How do they see equity in a disaster?
Okay, let's say you own a building that's worth
a million dollars. but you fell on hard times,
lost a big client, whatever. You owe the bank
$400 ,000 on your mortgage, and you haven't been
able to make a payment in six months? The bank
is about to foreclose and option it off on the
courthouse steps. You're about to lose everything.
A nightmare scenario. Right. A hard money lender
looks at that exact same situation and says,
wait a minute. You owe the bank $400 ,000, but
the building is worth a million. There is $600
,000 of equity trapped in that property. That's
real tangible value. It's real money. So the
hard money lender comes to you and says, look,
I will lend you $450 ,000. We'll use $400 ,000
to pay off the bank immediately and stop the
foreclosure. You'll have $50 ,000 left over to
make some repairs, clean the place up, and sell
it properly on the open market. So they act as
a lifeline. A very, very expensive lifeline.
But yes, the industry really developed historically
as exactly that, a lender of last resort for
property owners who needed to access their equity
when all the traditional doors were slammed in
their face. So if I'm hearing this right, the
hard money lender's pitch is basically, I see
you're in a tough spot, but I also see you have
a valuable asset. I'll give you the cash you
need, but the deal is, if you don't pay me back
on my terms, I'm taking that asset. That is the
fundamental tradeoff. And that brings us perfectly
to the mechanics of how they protect themselves.
Because if your business model is lending to
people in bankruptcy or in foreclosure or to
flippers who are taking on risky gut renovations,
how do you make sure you don't lose your shirt
every other deal? Right. If the borrower is inherently
risky, the lender must have a massive safety
net built in. They do. And it's a three letter
acronym. LTV, the loan to value ratio. This is
the golden ratio, the holy grail of the hard
money world. OK, let's break down LTV. It sounds
like something from a math class, but I have
a feeling this is where the rubber really meets
the road on these deals. It's the only number
that truly matters in the end. And the formula
is super simple. It's just the loan amount divided
by the value of the property. Simple enough.
But. Here is the kicker. A traditional bank on
a primary residence might lend you 80, 90, sometimes
even 95 percent of a home's value. Right. I just
have to put down 5 or 10 percent and the bank
covers the entire rest of it. In the hard money
world, that never, ever happens. There is no
such thing as 100 percent LTV or even 90 percent.
Most hard money lenders will cap their LTV at
around 65 percent of the property's current value.
65. That's a massive buffer. It is an enormous
cushion. And it's completely intentional. If
a property is worth $100 ,000 today, the absolute
most a hard money lender will give you is $65
,000. So where does the other $35 ,000 come from?
For the purchase. That comes from you. That's
the borrower's contribution. You have to have
significant skin in the game. Skin in the game.
These loans are for professional investors, and
the lenders will always require a much higher
down payment or for you to already have a lot
of existing equity. They want to know that if
you decide to just walk away from the project,
you are leaving a big chunk of your own money
on the table. That makes a lot of sense. It keeps
the borrower motivated to actually see the project
through to the end. If I have $35 ,000 of my
own cash tied up in a deal, I'm not going to
just disappear. You're going to answer your phone
when the lender calls. But it also protects the
lender in the absolute worst case scenario. Which
is foreclosure. Right. So let's say you default
on that loan. The lender has to take the house
back. Now they own a house that's worth $100
,000, but they only have a $65 ,000 loan on it.
Even if the real estate market suddenly crashes
and the value of that house drops to $80 ,000.
They can still sell it for $80 ,000. pay off
their $65 ,000 loan, and still walk away with
a profit after covering legal fees. Exactly.
That low LTV is designed to absorb market volatility,
holding costs, and the legal expenses of a foreclosure.
It's a huge margin of safety. Now, this brings
up a really technical but important point that
came up in the listener feedback in the research.
Value is a subjective thing. If I'm flipping
a house, there are really two values, aren't
there? There's what the house is worth now in
its dumpy condition and what it's going to be
worth after I fix it up. Yes. And that is the
critical distinction between the as -is value
and the ARV, which stands for after -retire value.
This seems absolutely crucial. Which one of those
values do they lend on? It really depends on
the specific lender and the deal. But this is
where the industry has gotten a lot more sophisticated
over the years. Many of the best hard money lenders
will actually lend based on the ARV, the future
value. Wait a minute. That sounds incredibly
risky. They're lending you money based on a value
that doesn't even exist yet. It sounds risky,
but they control the process very, very carefully.
Let's go back to our zombie house example. Purchase
price is $100. The renovation budget is $50.
The future value, the ARV, is $250 ,000. Got
it. A lender might come in and say, okay, our
rule is we'll lend you 70 % of the ARV. So 70
% of $250 ,000 is $175 ,000. Wow. Okay. That's
enough to cover the entire purchase price and
the renovation costs. It is. But, and this is
a very, very big but, they do not just hand you
a check for $175 ,000 and say, good luck, hope
you actually fix the house. So what do they do?
How do they manage that? They'll give you the
money to buy the house, so the $100 ,000, but
they hold the renovation money, the other $75
,000 in this case, in a separate escrow account.
And they only release it to you in stages, which
are called draws. Draws? Yes. So you go out and
you fix the roof. Then you call the lender. The
lender sends an inspector to the property to
verify that, yes, a new roof has been installed
and the work is done correctly. Then they release
the money to you for the roof. Then you do the
kitchen. They inspect. They pay you for the kitchen.
I see. So they're drip feeding you the renovation
money to ensure that the value is actually being
added to the property step by step. Precisely.
They are managing their risk throughout the entire
construction process. Their LTV is always protected
because the loan amount never gets too far ahead
of the actual current value of the house. That
is incredibly structured. It's so much more than
just, here's a bag of cash, see you in six months.
Oh, no. It is a very, very tightly managed process.
And speaking of value, they're also very specific
about how they determine it in the first place.
They don't just take your word that the house
will be worth $250 ,000. Right. The notes mention
something called liquidation value. That sounds
ominous again. It sounds ominous, but it's just
realistic. They aren't interested in what the
property might sell for in a perfect market with
six months of marketing, professional staging
and, you know, fresh baked cookies in the oven
for every showing. They're interested in the
fire sale price. They're interested in what they
can sell it for quickly if things go horribly
wrong and they have to take it back. So how do
they figure out that number? It can't just be
a guess. No, it's all data driven. They use a
few common methods. One is a BPO, which is a
broker price opinion. What's that? It's kind
of like an appraisal light. They pay a local
real estate agent a small fee to drive by the
property, look at the condition, pull some recent
comparable sales in the neighborhood and give
a quick professional opinion of what it would
sell for. And it's faster than a full appraisal,
I assume. Much faster and cheaper. A full appraisal
can take weeks. A BPO can be done in 48 hours.
Again, speed is the name of the game. Or for
a more complex deal, they'll order a full independent
appraisal done by a licensed appraiser in that
state. But the instruction is always. Give me
the value for a quick sale, 30 to 60 days on
market. So we have the mechanics down. It's a
low LTV, high interest, short term loan, often
with escrowed renovation funds. It's a machine.
It's a machine designed to monetize risk in a
very specific way. But where did this machine
even come from? Was there like a specific moment
in history where someone woke up and said, I'm
going to start a hard money lending company?
We can trace the origins of the modern industry
back to the late 1950s. The 50s. That seems counterintuitive.
I always think of the 50s as this golden age
of traditional banking. You get a free toaster
when you open a savings account. It was, but
the credit industry in the U .S. was also undergoing
some really drastic changes. As the post -war
economy boomed and real estate development took
off, there was this huge demand for capital that
the traditional, very conservative banks just
weren't meeting. The last resort option that
we talked about earlier. Exactly. It really started
out as private, wealthy individuals. You know,
doctors, lawyers, successful business owners
lending their own excess cash to local developers
they knew. It was very informal. A lot of handshake
deals. The guys in the trench coats. Maybe not
trench coats, but definitely guys at the country
club and in cigar bars. But if we fast forward
to today, the industry is having a bit of an
identity crisis. An identity crisis. How so?
Well, remember how we started this whole deep
dive saying hard money sounds like something
out of a crime film? Yeah, the broken kneecaps?
Well, the industry has finally realized that,
too, and they really don't like it. They want
a makeover. They want a full rebrand. The consensus
in the industry over the last few years is that
the term hard money just doesn't accurately describe
the direction, the structure, or the attitude
of the profession anymore. It sounds rough. It
sounds predatory. It sounds unsophisticated.
So what do they want to be called instead? Soft
money? Fluffy money? Laughs. Not quite. In March
of 2022, the National Private Lenders Association,
the MPLA, they passed an official resolution.
An official resolution. That sounds very serious,
like something the UN would do. It was very serious
for them. The resolution encouraged all industry
participants to completely drop the term hard
money. And replace it with what? They suggested
alternatives like private lending. bridge lending
or my personal favorite transitional lending
transitional lending yeah that sounds so much
more professional very corporate it sounds like
something you'd discuss in a glass conference
room not a back alley It does. And the other
big trade group, the American Association of
Private Lenders, the AAPL. Not the phone company.
No, not the phone company. They published this
big article called The Demise of Hard Money in
a Private Lending World. Their entire 2021 national
conference was basically focused on this exact
terminology shift. It's fascinating, isn't it?
They're trying to gentrify the name of their
own industry. That's a great way to put it. As
the industry has matured, institutional cap...
We're talking Wall Street money, hedge funds,
pension funds has started pouring into the space.
And you can't go to a pension funds board and
pitch them on investing in a hard money fund.
It just sounds too risky. But if you pitch them
on a private credit fund or a transitional asset
based lending strategy. Now, that sounds like
a smart, sophisticated portfolio diversification.
But here's the real question. Does changing the
name. actually change the reality of the deal?
No, not at all. It's still 14 % interest, right?
In most cases, yes. It's still a 65 % LTV. Yes.
And it's still ultimately based on the liquidation
value of the asset if the borrower defaults.
Absolutely. You can put a new, fancier wrapper
on the candy bar, but the candy inside is exactly
the same. It is high cost, high risk, asset -based
capital. So speaking of the rules of this game.
How regulated is this industry? Is it the Wild
West or are there sheriffs watching over it?
It's a mix. But generally speaking, the field
has always been formally unregulated by state
or federal laws in terms of its general operation.
Formally unregulated. That's one of those phrases
that always makes me a little nervous. Right.
It means there isn't a federal hard money commission
that's overseeing every single deal. A private
lender doesn't have the same kind of direct oversight
as, say, Bank of America. But that doesn't mean
there are no rules. Not at all. The biggest catch,
the biggest regulation they all have to follow
is usury laws. Usury laws. That's a term you
don't hear every day. That's like biblical. It
is. It's an old concept, but it basically just
means that there are legal limits on how much
interest a lender can charge on a loan. And these
limits are set by state governments. So a lender
can't just decide to charge 50 percent interest.
because they feel like it. In most states, no.
And this creates this really interesting patchwork
landscape across the country. For example, the
sources we looked at mentioned that lending operations
in states like Tennessee and Arkansas are described
as virtually untenable for these firms. Really?
Why those states specifically? It all comes down
to the math of their state usury laws. In Arkansas,
for example, the maximum interest rate you can
charge is tied to the federal discount rate plus
a certain percentage, often 5 percent. OK. So
if the federal rate is really low, the legal
maximum interest rate in Arkansas might be capped
at, say, 10 or 11 percent. But the whole business
model for hard money requires them to charge
12, 13, 14 percent to cover their risk and make
a profit. You've got it. If the state law says
you can only charge 10 percent, but your business
model requires 13 percent to even break even.
simply cannot do business in that state you have
to close up shop and go elsewhere so there are
literally hard money deserts in the united states
places where you can't get these loans yeah purely
because of old state laws yes The geography of
the industry is heavily dictated by these old
interest rate laws. But the biggest shift, the
one event that truly caused this industry to
explode in modern times, wasn't a state law.
It was the direct aftermath of the 2009 mortgage
crisis. And there it is. The aha moment of the
episode. It always comes back to 2009. It has
to because the hard money or private lending
mortgage market has expanded exponentially since
the passing of the Dodd -Frank Act. OK, Dodd
-Frank. We hear that name all the time. It was
the massive piece of legislation that was the
government's big response to the banks crashing
the economy. Right. And its main goal was to
stop banks from ever making those kinds of terrible
loans again. Part of that response was a major
update to the Truth in Lending Act or TILA. Sounds
deadly enough. Truth in lending. It introduced
a very powerful new rule called the ability to
repay rule or ATR. Ability to repay. Yeah. That
just sounds like basic common sense. You shouldn't
lend money to people who can't possibly pay it
back. In theory, yes, it's common sense. But
in practice, it meant that mortgage originators
were now legally required to rigorously evaluate
and document a borrower's ability to repay a
loan, specifically on primary residences. They
have to document income, assets, employment,
every little detail. No more NNG loans, no income,
no job, no assets. Those were gone overnight.
And here is the real kicker. Under Dodd -Frank,
If a bank makes you a loan and you default and
it turns out they didn't document your income
perfectly according to the new rules, the bank
can face enormous federal fines. The borrower
can even sue the bank to stop the foreclosure.
So the banks got scared. They got absolutely
petrified. Overnight, they stopped lending to
anyone who didn't fit into a perfect, easy to
document box. If you were self -employed, suddenly
you were too risky. If your income was irregular
or commission -based, too risky. If you were
a real estate investor with a complicated tax
return showing lots of deductions, the bank just
said no. It wasn't worth the potential legal
risk of a federal fund. And that created a vacuum.
A massive gaping vacuum. Suddenly, millions of
people, legitimate business people, investors,
entrepreneurs with good credit and real assets
found themselves completely locked out of the
traditional banking system. And the hard money
lenders stepped in to fill that void. They did.
But... and this is the most crucial part of the
modern industry, they did it by avoiding the
primary residence market entirely. How did they
do that? They made a very strategic shift to
focus specifically on business purpose or commercial
loans. Okay, explain the difference. Why did
that matter? Dodd -Frank and TILA and all those
ability to repay rules are designed to protect
consumers. They exist to protect the family buying
a house to live in. Okay, that makes sense. But
if you're an LLC buying a house specifically...
renovate and flip for a profit, you are considered
a commercial entity. You are a sophisticated
borrower. The government basically assumes you're
a professional and you know what you're doing.
So those strict ability to repay rules don't
apply to business loans. They do not apply. As
a business borrower, you don't get those same
consumer protections. And that means the lenders
don't have the same restrictions or legal risks.
Exactly. By sticking strictly to business and
commercial loans, the private lenders completely
avoid the risk of falling under those strict
Dodd -Frank, TILA, and Hopia guidelines. It created
this very clear dividing line in the market.
The big banks handle the slow, document -heavy,
highly regulated residential mortgages for homeowners.
And the hard money lenders handle the fast, flexible,
asset -based commercial and investment projects.
This is truly fascinating. So if I were to call
a hard money lender today about a property, would
they actually ask me if I plan to live in the
house? That will be one of the very first questions
out of their mouth. And if you say, yes, this
is for me and my family to live in, they will
hang up the phone. Really? Just like that? Or
they will very politely refer you to a traditional
mortgage broker. They literally cannot and will
not lend on owner -occupied homes because the
compliance costs and legal risks are just far
too high. They stay strictly in that business
purpose lane. So. In a strange way, the very
regulation that was designed to make the banking
system safer for consumers actually triggered
the massive boom in this alternative, high -interest,
largely unregulated lending market. It is the
classic law of unintended consequences. When
you squeeze the balloon in one place, in this
case, traditional banking, all the air just rushes
to another part of the balloon. In this case,
private lending. The demand for that capital
never went away. It just had to move to a different
provider who was willing to supply it. That's
a perfect way to look at it. So let's just zoom
out for a second. We have covered a ton of ground
here today. We really have. We've defined what
this stuff is. It's an asset -based loan secured
by real estate. And the hard... refers to the
property, the hard asset, not the difficulty
level. Correct. Collateral is king. We've looked
at how they manage their risk. That 65 % LTV
cap is really the shield that protects the entire
industry. They never lend the full value of the
property, so the borrower always has significant
skin in the game. Always. That's non -initiable.
Then we walk through the history. All the way
from the informal 1950s origins to this modern
branding crisis where they are desperately trying
to get everyone to stop saying hard money and
start saying private lending. Right. The gentrification
of the name. And finally, we saw how the 2009
financial crisis and the Dodd -Frank Act essentially
carved out the perfect modern niche for this
industry by pushing the big banks out of the.
messy but profitable lending space. It's a really
fascinating ecosystem. It's this parallel financial
system that operates right alongside the banks
we all see on every street corner. But it plays
by a completely different set of rules. It seems
like it's a vital part of the economy, too. It's
absolutely vital. Think about every house flipping
show you've ever seen on TV. Think about that
new apartment complex in your city that used
to be an old rundown warehouse. Think about that
zombie house in your own neighborhood that finally
got fixed up and sold to a young family. The
one we talked about at the beginning. Exactly.
The chances are extremely high that a traditional
bank did not fund that renovation. Private money
did. Hard money did. That's a fantastic point.
This industry is what fuels the renovation and
revitalization projects that the big banks are
now too risk averse to touch. Exactly. It provides
essential liquidity to a segment of the market
that would otherwise just freeze up and decay.
Without the source of capital, millions of distressed
or transitional properties would just sit there
rotting because no one could get the cash to
fix them. So for you, listening at home or in
your car, why should you care about this? Maybe
you're not planning on flipping houses. Maybe
you're just a regular person with a regular job.
Well, for one, whether you're an aspiring real
estate flipper or maybe someone who's just looking
for alternative places to invest your own money,
because remember, you can also be the hard money
lender. Wait, I can be the lender. I could be
the one charging 14%. Absolutely. Many of these
private lending funds raise their capital from
individual accredited investors. You can put
your money into a fund and they lend it out on
these deals at 12 or 14 % and they pay you a
return of 8 or 9%. It's a way to participate
in the real estate market without ever having
to swing a hammer. That is a whole other deep
dive for another day. It is. But even if you
never invest a dime. This is important because
it explains how so much of the world around you
actually gets built and rebuilt. It explains
how projects get funded when the obvious answer
from the bank is no. It explains the mechanics
of risk and reward in their absolute rawest form.
It's the engine of the alternative economy. It
really is. So I want to leave everyone listening
with one final thought to chew on. We talked
a lot about the rebranding effort. The industry
is trying so hard to be called private lending
or transitional lending. It sounds softer. It
sounds nicer, more professional. It definitely
does. But does a softer name really change the
hard reality of the transaction? At the end of
the day, the entire model still relies on the
liquidation value of your asset if you fail.
That is the provocateur's question, isn't it?
You can call it transitional lending. You can
call it boutique capital solutions. But if you
don't perform, the underlying mechanism is exactly
the same. They are coming for the asset. The
collateral is and always will be the king. It's
something to think about. The next time you're
stopped at a red light and you see one of those
yellow corrugated plastic signs stapled to a
telephone pole that just says, we buy houses
for cash. There is a whole world of these hard
money mechanics grinding away right behind that
simple little sign. Indeed there is. Thanks for
diving in with us on this. My pleasure. It was
great. And we'll see you on the next Deep Dive.