Understanding the Interest Rate Challenges in Alternative Lending

Today, you can easily search for home-mortgage interest rates online and run a comparison among different non-traditional 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 information is because there are several factors driving hard money loans, such as federal fund rates.

Other factors influencing interest rates in the alternative financing include:

Speed and Supply

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

Nontraditional loans also process faster, with deals closing in one to three weeks, unlike in traditional lending where borrowers have to wait for 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 speed of the closing 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

One other 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 influences 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 cost of foreclosure in the state. States with a longer and more costly foreclosure process attract a higher interest rate.

There are more factors beyond those stated here that influence interest rates in hard money lending. Alternative loans rely on a different set of factors than traditional loans, making the prediction of interest rates a lot harder. It is therefore important for lenders and borrowers to 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