Hard Money Terminology
Many real estate investors don’t understand terms used in the products and programs of hard money, bridge loans and others. To help our potential clients we have included a short listing of commonly used lending terms below.
Adjustable Rate Loan
Also called a floating rate loan or a variable rate loan, refers to a loan that does not have a fixed rate of interest over the life of the loan. Such a loan typically uses an index and some base rate for establishing the interest rate for each relevant period. One of the most common rates to use as the basis for applying interest rates is the London Inter-bank Offered Rate, or LIBOR (the rates at which large banks lend to each other).
After Repair Value (ARV)
The after repair value is determined by the appraisal ordered after your hard money loan application is submitted. We consider loan amounts of up to 65% of the estimated ARV.
Statement of value as of a certain date. It is prepared by a licensed and/or credentialed expert who has complied with the training requirements of the state and/or one of several recognized appraisal institutes.
One to whom a transfer of an interest is done.
Written document by which an interest, other than real property, is transferred from one entity/person to another.
Bad Boy Carve-outs
(to non-recourse loans) are exceptions within the loan documents that result in full-recourse liability to the borrower and the guarantor when certain bad-boy behaviors exist. Examples of these bad-boy behaviors are (i) fraud or intentional misrepresentation by the borrower; (ii) waste occurring to or on the mortgaged property; (iii) gross negligence or criminal acts of the borrower that result in the forfeiture, seizure or loss of any portion of the mortgaged property; (iv) misapplication or misappropriation of rents, insurance proceeds or condemnation awards received by the borrower after the occurrence and during the continuance of an event of default; and (v) any sale, conveyance, mortgage, grant, bargain, encumbrance, pledge, assignment or transfer of the mortgaged property, or any part thereof, without the prior written consent of the lender.
Balloon Payment Mortgage
a mortgage which does not fully amortize over the term of the note, thus leaving a balance due at maturity (see also “Bullet Loan”).
these are standard contract clauses which use universal language as a type of template. Usually found at the end of a contract, boilerplate clauses include insurance terms, arbitration clauses, notice provisions, jurisdictional and governing law clauses and force majeure clauses. In loan documents these terms are often ignored but may be important in the event of a property casualty, loan default or other issue concerning the property.
Bridge Loan a short-term interim loan, often at a higher than market interest rate and with larger than usual origination fees (points), used to quickly effect the purchase of real property while pursuing more conventional longer term real estate financing, Bridge Loans in the real estate context are very often also referred to as “Hard Money Loans”(see below).
a category of economic rights or obligation within a Waterfall provision (see below).
a loan without amortization where the payment of the entire principal of the loan, and sometimes the accrued principal and interest, is due at the end of the loan term.
a limitation on the maximum interest rate that can be charged on an adjustable rate mortgage during the term of the loan.
refers to all of the capital invested in a project, including pure debt, hybrid debt, and equity. The stack is generally described from top to bottom going from the category of capital with the most risk at the top going down the stack to the position with the least risk. The higher the position in the stack — the higher the returns that can be expected for that capital because of the increased risk. Typically, the stack is arranged as follows.
1. Sponsor equity;
2. Preferred Investors equity;
3. Mezzanine investors (hybrid debt and equity);
4. Second and other junior mortgages; then
5. Investment-grade first mortgages.
Or Cap Rate is the ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset) or alternatively its current market value The rate is calculated in a simple fashion as follows:
Cap Rates provide a tool for investors to use for roughly valuing a property based on its net operating income. For example, if a real estate investment provides $160,000 a year in Net Operating Income and similar properties have sold based on 8% cap rates, the subject property can be roughly valued at $2,000,000 because $160,000 divided by 8% (0.08) equals $2,000,000. A comparatively lower cap rate for a property would indicate less risk associated with the investment (increasing demand for the product), and a comparatively higher cap rate for a property might indicate more risk (reduced demand for the product).
Carve Out Guaranty
the guaranty typically required by a lender of one or more principals of a borrower in connection with the non-recourse carve out obligations under a mortgage loan.
Or Cash Trap, the process by which any net cash flow (beyond a borrower’s operating costs and debt service) goes into a lender-controlled account. Often activated by the borrower’s failure to meet a financial test and accompanied by a Lockbox (see below).
Title that is not encumbered or burdened with defects.
Fees charged to a purchaser by a bank, lawyer, etc. for services related to a sale, such as a title search, appraisal, etc.; any expenses over the purchase price of a house, land, business, etc., that is paid by the purchaser or seller at the completion of the sale. Other costs include estimated title fees, recording fees and taxes, etc (if applicable).
Any claim, encumbrance or defect that contradicts the title record as understood by the property owner or interested party
Collection Account Charges
Lenders may do the collection and accounting of their own loans, ask our office to administer their loans, or ask another third-party to perform this service. If our office does the loan collection and accounting (which is generally the case), the collection account charges will be as specified in our page entitled Collection Account Services. The borrower is expected to pay the collection account charges.
Combined Loan-To-Value Ratio (CLTV)
The total amount of all debt secured by the security as a percentage of the total estimated value of the security. So, for example, if the loan is a first position loan for $60,000, and the seller is carrying back a second position note for $20,000, behind the private-money lender, and the property is deemed to be valued at $100,000, then the LTV is 60% and the CLTV is 80%. The acceptable CLTV will vary based on the lender and the situation, but may in fact, under the right circumstances, exceed 100%.
Dependent upon an uncertain future event or condition
the total structure of mortgage and other debt for a property. Part of the Capital Stack; may include a permanent loan, Mezzanine Loans (see below), and other varieties of debt.
A written document that transfers ownership of land from one party to another. The seller is called the “grantor” and the buyer is called the “grantee”. Deeds may be of many kinds. Depending upon the language of the deed, the legal capacity of the grantor, and other circumstances.
Deed of Trust
A three party security instrument conveying the legal title to real property as security for the repayment of a loan. The owner is called the “Grantor”. The neutral third party to whom the bare legal title is conveyed is the “trustee”. The lender is the “beneficiary”. When the loan is paid off the trustee is directed by the beneficiary to issue a deed of reconveyance to the Grantor, which extinguishes the trust deed lien.
The funds taken from a construction loan through a process referred to as a draw. A draw is the method by which funds are taken pursuant to a construction budget to pay material suppliers and contractors. Each lender has different requirements for processing a draw. This process helps ensure that the loan proceeds are actually used for the construction and that the construction process is moving smoothly.
the investigative process that persons involved in buying, selling, lending, and managing of real estate routinely need to perform to understand both the physical and economic condition and of a property. There a variety of types of property due diligence that are typically conducted. Environmental due diligence during can include Phase I and Phase II Environmental site assessments. An engineering or property condition assessment (PCA) would include a review of building systems to evaluate deferred maintenance items that can materially affect the operation and value of a property. Building systems would include the foundation, roof, HVAC, electrical, plumbing, vertical transportation, and building envelope (windows and walls). The due diligence should also include an analysis of financial statement, income and expense statements, rent rolls and tax returns relating to the property. All of these reports are useful for negotiating the price of a property as well as financial planning.
The due diligence in a real estate transaction also includes a title search regarding the ownership of the property and the encumbrances to which it is subject as well as research as to the applicable zoning laws, building code compliance and property taxes and other special assessments applicable to the property.
Due on Sale Clause
Provision in a deed of trust calling for the total pay-off of the loan balance in the event of a sale or transfer of title to the secured real property.
typically refers an ownership position or other profit participation in connection with the advancement of a loan. For instance, a hedge fund that lends money to a real estate developer might receive as an equity kicker a negotiated percentage of ownership in a project when completed. In return for that equity kicker, the borrower may be able to obtain a lower interest rate on the loan.
An impartial third party that acts on behalf of either seller/buyer or borrower/lender in carrying out the principals’ instructions through to an eventual “closing”. Escrow acts as the custodian for the documents and funds involved – and makes disbursements, delivers documents and effects the consequential changes to the title record of the subject property.
First trust Deed
A lien on real property which is superior to any other lien of record.
refers to a shutdown of operations by a big box or other major anchor retail tenant, often without assigning the lease or subletting the space to another operator. This shutdown can potentially damage other tenants and, in the worst case, destroy an entire shopping center.
Go Dark Clause
a provision in a lease giving the tenant the option to terminate a lease or receive a reduction of rent, if another identified tenant (typically a large recognizable name tenant (anchor or big box tenant) goes out of business or leave the premises. The lease clauses are very often found within the context of retail shopping centers.
When a buyer has determined not to exercise a due diligence “out” of the contract or that the expiration of the deadline to cancel the contract has occurred. After this point Buyer may forfeit the contract deposit if it does not or can not close the transaction on the closing date.
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A deed used extensively in several States to transfer title. There are a number of implied warranties attributed to it, the main ones being that the grantor has the right to convey the property, and that the grantor hasn’t encumbered the property any more than already disclosed. The grantee may hold the grantor liable if the title proves to be defective.
the direct costs relating to construction or improvement of a building or other structure, as opposed to other “soft cots” such as legal, financing, architects’, and similar fees required for the project.
1) Private funds used for the purchase of real estate by investors
2) Financing given to individuals who are unable to qualify for standard financing and the amount is typically based on the current equity in the home.
3) a specific type of asset-based loan financing through which a borrower receives funds secured by real property. Hard money loans are typically issued by private investors or companies. Interest rates are typically higher than conventional commercial or residential property loans because of the higher risk and shorter duration of the loan. Most hard money loans are used for projects lasting from a few months to a few years. Hard money is similar to a bridge loan, which usually has similar criteria for lending as well as cost to the borrowers. The primary difference is that a bridge loan often refers to a commercial property or investment property that may be in transition and does not yet qualify for traditional financing, whereas hard money often refers to not only an asset-based loan with a high interest rate, but possibly a distressed financial situation, such as arrears on the existing mortgage, or where bankruptcy and foreclosure proceedings are occurring.
Hard Money Loan
a mortgage loan with an above market interest rate and expensive closing fees (points) usually from a non traditional lender often obtained as a Bridge Loan (see above), because of borrower distress or in order to meet financial requirements of a project beyond the acquisition.
Hard Money Loan Calculator
A calculator to estimate your total estimated costs, the estimated Loan-to-Value ratio and the estimated cash needed to determine the loan costs of hard money and loan payment. See our Hard Money Loan Calculator here to use free.
refers to monies held back by a lender from a loan until such time as a certain conditions at the property are met such as the leasing up of a certain percentage of the property, the completion of certain capital improvements or repairs or the disposition of a legal action.
Interest Reserve instead of paying each month during construction, almost all construction loans require the borrower to borrow extra funds at the initial closing of the loan which are stored in a locked account known as an interest reserve. Each month the monthly payments are taken from the account so that the borrower does not have to start paying out of pocket until the project is completed.
Instrument of Security
Also known as paper, this is the legal documentation that provides the framework for the relationship between the borrower, the lender, and the security. The instrument of security may be a note and trust deed, a land sale contract, a mortgage, or a lien holder title (with manufactured homes or floating homes, for example).
The interest reserve is pre-paid interest. Most of our loans will include interest reserved at closing. Interest is generally calculated at 1 percent monthly (12% annually).
• For example, a $100K loan would carry $1000 monthly in interest.
The additional amount due to a lender when a payment is not paid by the borrower within the agreed upon grace period. Typically the late charge amount will be a percentage of the late payment amount and will become due after a certain grace period has passed.
refers to the ability of the borrower to receive some cash from property sales (often in a condominium project) before the loan has been fully repaid.
A claim against real property.
Market Value The current value of property as determined by exposure to offers from willing buyers in the open market.
The costs associated with putting together a loan. They are paid at the time loan funds are disbursed (though commission arrangements may vary) and are generally paid by the borrower, though they are often paid from the proceeds of the loan. They include: the commission that is paid to the Loan Broker(s), the cost of title insurance (see our article, Why Title Insurance?), the cost of closing a deal through escrow at a title company, and the cost of recording official documents. Sometimes they include appraisal fees, or on occasions, document preparation or IRA rollover fees.
Loan-To-Value Ratio (LTV)
With regard to a first position loan, this is the total amount of the loan as a percentage of the total estimated value of the security. With regard to a subordinate position loan (a second or third, for example), this is the total amount of the loan added to the total amount of all superior liens as a percentage of the total estimated value of the security. The acceptable LTV will vary based on the lender and the situation, but generally 60-80% is considered acceptable, depending on the type of security.
also known as cash management agreement, refers to an arrangement by which rent gets paid by tenants directly to a particular bank account (subject to a lender security interest) to be applied in accordance with a Waterfall.
Refers to secondary financing on a project, similar in purpose to a second mortgage, except that a mezzanine loan is secured by the equity interests of the company that owns the property, as opposed to the real estate. If the company fails to make the payments on the loan, the mezzanine lender can generally foreclose on the equity in a much simpler and expedited time in comparison to the often complex and timely mortgage foreclosure process. Once lender owns the company that owns the property it controls the property.
Also Collateralized Mortgage-backed Securities or CMBS, are a type of asset-backed security that is secured by a mortgage or collection of mortgages. These securities are grouped and rated by an accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments. The underlying mortgages must have originated from regulated and authorized financial institutions.
Notice of Default
The first phase of the two step foreclosure process in most States. The notice, which is prepared and either recorded, mailed and/or posted by the foreclosing trustee, contains particulars regarding the default in payment, the affected deed of trust, etc. The default period time to allow the debtor time to bring loan current or payoff.
Points Are an “upfront fee” on a loan that is incurred at the time of the loan. Each point is equal to 1% of the value of the loan. The points are often wrapped into or included in the loan to reduce the borrower’s upfront fees.
means long-term financing for real property that has achieved Stabilization. These loans typically requires monthly amortization and include a fixed rate of interest.
A point is one percent of the total loan amount. We generally charge between 4 and 8 points depending on the loan type and amount.
The position defines the order in which claims against the security will be satisfied in the event of a foreclosure. Most lenders prefer to lend only in the first position, but some lenders will go in a subordinate position (second, third, etc.) in exchange for a higher rate of return.
The penalty (if any) that a borrower must pay to a lender if a loan is repaid early. Most loans placed through our office do not have a pre-payment penalty in the traditional sense, but rather may have a three- to six-month minimum interest clause. This means that a loan must return at least three or six months in interest to the lender. For example, if a loan is repaid in six months or more, no penalty is assessed. However, if a loan is repaid in less than six months, the penalty is equal to six months interest less the interest already paid.
Private Money Lending
Also commonly referred to as hard money lending, this terminology describes situations in which private individuals (as opposed to financial institutions) lend money to other individuals (or businesses) in exchange for a fair rate of return on the use of the funds.
or Loan Proceeds or Net Proceeds, means the net amount of funds disbursed by a lender to a borrower (after the deduction of lender, fees and other transactional expenses), under the terms of a loan agreement.
REO (“Real Estate Owned” or “Other Real Estate Owned”) refers to real estate that a bank has acquired through foreclosure or a deed in lieu of foreclosure and is carrying on its balance sheet.
The purchase price is the amount of money for which you will be purchasing the subject property.
The percentage compensation to be paid by the borrower to the lender at fixed intervals (usually monthly). Rates are quoted as annual charges. Interest rates vary with both the state of the economy and the perceived risk involved with a particular loan. Most first position loans placed by our office during the past few years involved rates ranging between 11% and 15%.
The rehab costs are the total amount outlined in your rehab scope-of-work. Ultimately, it is the amount of money needed to pay for the renovations that will make the subject property worth the estimated ARV.
the process pursuant to which mortgage loans are purchased from banks and other lenders and assigned to a trust, assembled into collections or pools, then securitized through the issuance of Mortgage-backed Securities.
Shotgun refers to a mechanism sometimes inserted into some joint venture agreement pursuant to which one partner can force a buyout procedure by naming a price for all the assets of the joint venture (commonly that price is based on the distributions that the join venture would make if it sold all its assets for the stated price). The other partner must then either buy out the initiating partner, or sell to the initiator at the stated price.
Although almost anything may be used as security, or collateral, to effectively secure a loan, our office generally only places loans that are secured by real estate (with the exceptions being floating homes, manufactured homes, and occasionally stock shares).
Single Purpose Entity
a newly formed entity, the sole purpose of which is to own and operate a particular property or project, which is often required by lenders (particularly CMBS lenders).
a lender’s determination of the final loan amount.
Stabilization means the point at which a project, development or acquisition has become income-producing real estate by achieving a certain level of completion, lease-up and/or net income.
an agreement in which a borrower (typically under a floating rate loan) agrees to pay a fixed rate and a counterparty agrees in exchange to cover the borrower’s floating rate loan payments.
value that is added to a property by a developer or sponsor who add value through its intangible efforts such as by obtaining favorable zoning rights, obtaining municipal consents, negotiating favorable rights with adjacent property owners or assembling other properties required for the development, creativity in project design, or lining up future tenants. The sponsor/developer will often negotiate for the right to convert its sweat equity into a larger share of the profits or future value of the completed project.
refers to a lender’s commitment to provide a permanent loan for a property (i.e., refinance of the construction loan) after completion of construction and, in many cases, Stabilization.
Tranche usually refers to the particular priority a loan has for application of foreclosure sale proceeds. Higher tranches have lower risk and lower interest rates than “lower” Tranches.
This refers to the length of a loan and the amortization. Most loans placed by our office are either 1-3 year loans with a interest only payments (no amortization). In some cases, we may make longer term loans of 4-6 years with a 20-30 year amortization (an N year amortization defines the payment amount necessary to pay the loan balance down to zero in N years time).
There are different ways to establish the value of a security, and one or more may be used in any given situation. Among these are the following: (1) previous transfer price(s) for the property, (2) tax assessed value, (3) appraised value, as assigned by a paid and impartial licensed appraiser, (4) a Market Value Analysis (MVA) provided by a Realtor, (5) transfer prices for comparable properties, (6) an income analysis, (7) an evaluation of the cost basis for the property.
the provision in an agreement which dictates the order of priorities with respect to the application and distribution of available cash proceeds from a particular project or property.
the negotiated resolution of a troubled loan.