Understanding the Interest Rate Challenges in Alternative Lending

Today, you can effortlessly search for home-mortgage interest rates online and run a comparison among different nontraditional lenders. However, running similar comparisons with private money loans is harder. Both borrowers and brokers want information on interest rates among hard money lenders. The lack of knowledge is because several factors, such as federal fund rates, drive hard money loans.

Other factors influencing interest rates in alternative financing include:

Speed and Supply

Supply and demand influence interest rates; for example, the increase in hard money loans in California has driven down the interest rates. Non-conventional loans rely on the asset's value as opposed to the borrower's financial credibility. Between hard money and private money loans, the former depends on a more formal structure with some regulation. In contrast, the latter offers more flexible terms with finances from individuals, friends, and family members.

Nontraditional loans also process faster, with deals closing in one to three weeks, unlike traditional lending, where borrowers have to wait up to three months to access the loan. Borrowers in a crunch to close a deal or pay off a debt can access financing faster. The closing speed affects the interest rates: for example, a loan that needs to close in two days will have a higher interest rate than a loan that can wait a month.

Location and Value

Another major factor influencing interest rates in alternative lending is the loan-to-value, LTV, ratio. The reliance on collateral instead of the borrower's creditworthiness means that the LTV controls the interest rate. In these types of loans, an individual's creditworthiness takes a backseat. When it comes down to the LTV, a lower LTV translates to a lower interest rate and vice versa.

The location of the collateral also comes into play when determining interest rates. Hard money loans rely on assets, and lenders must consider the time it will take to close the deal and the state's foreclosure cost. States with a more prolonged and costly foreclosure process attract a higher interest rate.

More factors beyond those stated here influence interest rates in hard money lending. Alternative loans rely on different characteristics than traditional loans, making predicting interest rates much harder. Therefore, lenders and borrowers must assess each deal without using the given interest rate as a guarantee. Every lender should weigh factors influencing the loan, such as LVT, supply, location, and speed, before quoting the interest rate — plus other external and internal factors specific to the deal.