Why Defaulting on a Hard Money Loan Is Bad News

Taking out a loan is risky business for both borrower and lender. The borrower’s biggest risk is default. Should a borrower do so, the consequences could be quite severe. This is easily illustrated in the hard money arena. Defaulting on a hard money loan is bad news – even more so than defaulting on a mortgage or business loan.

For purposes of clarification, a hard money loan is a cash loan provided by a private lender and based on the value of some sort of collateral. In almost every case, hard money loans are offered on real estate transactions and are backed up by the properties being acquired. The rest of this post will discuss default based on such a scenario.

What Constitutes Default

As hard money lenders are governed by the same rules as traditional mortgage lenders, their conditions for default can be quite different. Understand that a typical hard money loan requires monthly interest payments along with a final balloon payment of the principal at maturity.

Where a traditional mortgage might not be considered in default until 90 days after the first payment is missed, hard money loans can be in default after just one missed interest payment. Even making a partial interest payment could be considered grounds for default if the language of the loan contract stipulates as much. The simplest way to understand default is any scenario in which the borrower doesn’t abide by the terms of the contract.

Why Default Is So Bad

Defaulting on a hard money loan is particularly bad for several reasons. First, thirty states and the District of Columbia follow non-judicial foreclosure rules. This is to say that lenders do not have to appear in court in order to foreclose on properties. Where judicial foreclosures could take years, non-judicial foreclosures can be completed in a matter of months. Simply put, it is a lot easier to foreclose in a non-judicial state.

Utah is one such state, according to Utah hard money lenders, Actium Partners. Once in default, it doesn’t take long for private lenders to begin taking action. But above and beyond that, it is not uncommon for hard money lenders to package their loans and sell them to investment funds that are less willing to work with investors to bring accounts current.

How to Avoid Default

The typical default scenario results in the lender giving the borrower thirty days to bring the account current. Should the borrower fail to do so, foreclosure is the normal result. The obvious lesson here is that it’s best to avoid default altogether.

One of the more common reasons for defaulting on hard money loans is being over leveraged. In other words, investors stretch their resources to the absolute limits. When something goes wrong, they do not have enough cash flow to continue making loan payments. Don’t over leverage and your risk of defaulting goes down.

Another way to avoid default is to obtain traditional financing to pay off the hard money loan. Traditional loans tend to have lower interest rates and more generous terms. The result could be lower monthly payments spread out over longer periods of time.

Should default seem inevitable, it always pays to try communicating with the lender in hopes of working something out. Not communicating only antagonizes a lender to the point of encouraging foreclosure action.

Hard money is a great tool for real estate investment. But defaulting on a loan is bad news. Hard money lenders tend to take action more swiftly and are less forgiving. It is best to not even take the risk.