When a new prospective borrower states they need 100% financing the lender will instantly be reluctant to provide financing. This simple statement tells a great deal about the borrower and asks too much of the lender.
1. The borrower is likely not financially strong
When a hard money borrower needs 100% financing this immediately calls into question the overall financial strength of the borrower. With little cash to commit to the project will the borrower be able to make payments on the loan? Do they have cash reserves set aside to deal with any unforeseen issues that may arise with the project? The last thing a lender wants to do is loan money out to a borrower who isn’t going to be able to pay it back on time.
2. The borrower is most likely inexperienced in real estate
Borrowers who think they will be able to obtain 100% loan to value (LTV) hard money loans to invest in real estate probably haven’t done many deals if any. With inexperience comes the likelihood that the real estate investor will make mistakes that will cost them money and jeopardize the project. Borrowers with some real estate investing experience will have been exposed to the lending process and figured out that lenders do not provide 100% of the funds to purchase a property.
3. The borrower is asking the lender to assume all of the risk
Hard money loans are asset based. The loan is secured by the real estate (asset) being used as the collateral for the loan. The borrower must have sufficient equity (generally at least 25%) in the property which ensures the borrower is committed to the property / project and protects the lenders from some downside risk if something with the project goes wrong or the overall market takes a downturn. If the borrower has no equity in the property the lender is assuming all of the risk. Lenders need to reduce their risk whenever possible so they can retrieve their investments and continue lending money.
If the borrower owns a property but has no equity in it, any decrease in value creates the potential of a loss for the borrower. If the borrower has no equity in the property to protect, they may choose to abandon the project and property altogether. When a borrower stops making payments and the property is abandoned, the lender is forced to take back the property and salvage as much value as possible. This is a terrible situation for a lender to be in since the lender is no longer receiving loan payments and they are taking back a property worth less than the amount they initially loaned out. If the borrower had equity invested in the property they would have had more financial incentive to make sure the project was completed successfully.
The Dangers of 100% Financing
100% financing (and even some financing above 100%) was largely responsible for the real estate bubble and collapse of 2007. When the real estate market started declining, many homeowners with 100% LTV loans realized they owed more on their mortgage than their property was worth. Many decided to walk away from their properties and be foreclosed upon, which caused the real estate market to collapse even further and drag the overall American economy down with it.
Why do many new borrowers think 100% financing is available?
The biggest hurdle to most new real estate investors getting started is usually lack of funds. Real estate gurus selling their programs via infomercials or at pricey seminars understand this and assure their prospective students they will learn how to invest in real estate without investing any money of their own. While this sounds promising, it usually involves convincing other people with personal retirement accounts to provide the funds for investment or taking out lines of credit with 0% introductory rate credit card offers. These are options that may work for some real estate investors but they can be very risky endeavors that can end in financial ruin.
Hard money lenders want their borrowers to succeed
When hard money lenders provide a loan, they want to be confident that the borrower is able to repay the loan on time. If the borrower isn’t able to pay back the loan, this creates a great deal of extra work, stress and potential financial loss for the lender. A strong borrower with a significant down payment (or equity in the property) and cash reserves has the best chance of obtaining a hard money loan and succeeding with their real estate project.