With a total market size of over $465 billion, the growing demand for asset-based lending ensures the investors are opting for hard money loans while putting their property upfront. Though there are very few chances of real estate investors defaulting on their hard money loan, one needs to consider the repercussions of it.
What happens if you default on a hard money loan?
1. Loss of Asset
The asset provided as collateral is the biggest security in hard money loans. Investors generally understand the fact that they can lose the asset if they default on a hard money loan. Most investors buy a property while paying almost 20% to 30% towards the down payment, so they might lose any investment made on the property
Since hard money lenders wish every investor to succeed in their investment project, it increases the chances of repeat business. Lenders don’t want any investor to lose an opportunity that will be fruitful for both parties. So a hard money lender will provide all the information and guidance on what happens if the payments are late or in case you end up defaulting on the loan. All the details regarding the loan duration, amortization period, and terms of foreclosure will also be mentioned separately in the respective contract.
2. Toll on your credit score
Another unfavorable thing to happen if you default on a hard money loan is losing your credit score. Investors may have to face the risk of losing almost 80 to 120 points (depending on the condition of default) off their credit score. A poor credit score means low chances of getting any kind of traditional loan.
An investor should avoid defaulting on a hard money loan in order to keep their credit score intact if they wish to refinance the loan with a traditional mortgage loan. Financial institutions determine the credit score of a borrower in order to determine the interest rates to be charged on a loan. Generally, people with a credit score between 300 to 549 will get the highest rates and be considered riskier, while people with a credit score between 740 to 850 will get lower rates and be considered risk-free. Let’s have a look at the average mortgage rates offered by the credit score of a borrower.
|Status||Credit Score||Mortgage Rates|
|Excellent||740 – 850||3.8%|
|Good||680 – 739||4.1%|
|Fair||620 – 679||4.8%|
|Poor||550 – 619||5.7%|
|Bad||300 – 549||8.6%|
Apart from this, the borrower will have problems finding a house for rent because of the poor credit score. Hard money lenders usually determine the exit strategy laid out by the investor before signing a contract with them.
3. Losing the down payment
Hard money loans require a borrower to pay about 20% to 30% of the loan amount towards the down payment, depending on their financial situation. It is generally used to determine the ability of a borrower to repay the loan. In some cases, the borrower may be able to put money down but still end up defaulting on a hard money loan.
It is important to understand that hard money lenders do not make money from foreclosure and will sell your property at a price enough to pay off the remaining loan amount. In case of a fix and flip project, the borrower will not only lose the property but also any investments made to improve the property.
Foreclosures are the last thing you can think about in a hard money loan. But it is important for an investor to consider before getting into it. A foreclosure may occur due to delinquent payments, illegal transfer of the property, or breach of contract. Hard money loan foreclosures cost both time and money, therefore considered a last resort.
There are mainly two types of foreclosures related to hard money loans,
1. Judicial foreclosures
In this type of foreclosure, if the lender is unable to get enough money to pay off the note through the foreclosure auction, they are allowed to sue the borrower to recover the remaining loan amount.
The judicial foreclosure also allows the ‘right of redemption to a borrower, depending on the situation. This means a borrower can repay the loan and acquire the title within a certain time frame after the foreclosure sale (may vary by state).
2. Non-Judicial foreclosures
Most of the hard money lenders avoid judicial foreclosures using the trust deed. In order to do this, they need to implement the state laws and follow the procedures of the trust deed, which is known as non-judicial foreclosure.
The process includes a lender issuing timely notices to the borrower, and if the borrower still couldn’t bring the loan current, then the property is subject to put on a trustee’s sale. In this way, after the sale, a lender will have ownership of the property and the borrower will have no right to redemption or any other option to retain the title after the property is sold
How to avoid defaulting on a hard money loan?
As most of the hard money lenders make most of their income on interest rates and loan points they are hardly after your property. Hard money lenders are willing to negotiate on each stage of the loan, even if you are near to default. A borrower can opt for the following options to avoid defaulting on a hard money loan:
Selling the property
The best way to avoid defaulting on your hard money loan is to sell the property before the loan matures. A borrower can sell the property above the purchase price while making some minor renovations. This is a common practice in fix and flip investment projects. Some hard money lenders cover the renovation costs in the loan amount, too.
Refinancing the loan
Investors can choose to refinance their existing hard money loan with a conventional mortgage loan to avoid defaulting on it. This allows investors to avoid foreclosure while allowing them the breathing room to sell the property in order to pay off the loan. Another benefit of refinancing a hard money loan with a mortgage loan is the low-interest rates and longer repayment schedule.
Taking another hard money loan
Another strategy to avoid defaulting on a hard money loan is to take another hard money bridge loan. A borrower can simply take another hard money loan from a different lender to pay off the existing loan. This allows a borrower to buy some time to sell the property and fix their credit score.
Though there are fewer chances of investors defaulting on a hard money loan. But one should consider all the scenarios before opting for a hard money loan from a private lender. Investors should plan out their exit strategy and execute it accordingly to avoid such situations.
If a borrower happens to default on their hard money loan, lenders like 14th Street Capital will work with them to come up with other options to repay the loan. We will determine all the scenarios and reasons behind delinquent payments to primarily avoid foreclosure. We understand your financial needs and provide hassle-free hard money loans that best suit your requirements.