It is not often you hear people talking about hard money, loan-to-value (LTV) ratios, and distressed properties in the same sentence. But it turns out that the three actually create a curious combination. So much so that pairing hard money with lower LTVs could still be a better deal when investors utilize hard money to obtain distressed properties.
Actium Partners, a Salt Lake City hard money lending firm operating in three states, explains that the majority of hard money loans go toward financing real estate acquisitions. Actium further explains that LTVs on hard money loans tend to be significantly lower than those offered on conventional loans. But that is not always a bad thing. In some cases, it can be very good.
LTVs and How They Work
An LTV is a representation of the total amount a lender is willing to lend based on the value of the property being acquired. LTVs are typically based on one of two things: the currently appraised value of the property or the purchase price.
Traditional lenders subject to federal law must choose the lower of the two. So if you have a property valued at $500k and a purchase price of $400k, the LTV would be based on the purchase price. With an LTV of 75%, the maximum loan amount on that lower number would be $300k.
Hard money lenders are private lenders. They are subject to the same federal regulations. As a result, hard money lenders are able to base their LTVs on the higher number – which they often do. If a hard money lender offered an LTV of 65% based on the value of the property rather than its purchase price, the maximum loan amount on a $500k property would be $325k.
How It Applies to Distressed Properties
Applying all of this to distressed properties makes things really interesting. Understand that a distressed property is one that is either in the process of foreclosure or on the verge of being foreclosed upon. In the case of the latter scenario, an owner is trying to sell the property before foreclosure proceedings begin.
Distressed properties are typically sold for less than market value. Once in foreclosure, a bank simply wants to get its money out. It doesn’t necessarily need to sell the property at market value. As for owners trying to avoid foreclosure, they typically go for what is known as a ‘short sale’. They sell the property as-is for whatever amount they need to pay off what they owe.
Now, consider that same $500k property with an outstanding balance of just $250k. Even at 50%, a hard money lender’s LTV provides enough cash to purchase the property without a significant down payment from the borrower. But if a lender’s LTV is 65%, the investor could wind up with cash to put toward rehab or even making monthly payments.
Perfect for Distressed Properties
I am by no means an expert in either hard money or real estate investing. But from where I sit, hard money seems to be perfect for acquiring distressed properties. Combining fast cash with sale prices that can be significantly lower than market value, makes distressed properties viable investment opportunities even though hard money LTVs are significantly lower.
A lower LTV is not necessarily a reason to avoid hard money. In many cases, the lower LTV is offset by other things. And in a small number of cases, borrowing from a hard money lender could net an investor extra cash even with the lower LTV. And now you know why investors have a thing for distressed properties.