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Hard Money Loans: The Hard Truth

Hard money loan's costs, terms often more onerous than conventional mortgages

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DEAR BENNY: What is a "hard money" loan? –Irene

DEAR IRENE: Technically, are hard money loan is a loan that is given in exchange for money, rather than to assist a consumer in buying a house. The latter would be called a "purchase money" mortgage.

Hard-money lenders do not rely on the creditworthiness of the borrower. Instead, they look to the value of the property. The lender wants to make sure that if the borrower defaults, there will be sufficient equity in the property over and above the amount of the loan. Accordingly, you will not get a hard money loan of 80 or 90 percent loan to value; typically, they will range from 50 to 70 percent loan to value.

Such loans are considered "loans of last resort." If you are unable to get a conventional loan from a bank or mortgage broker, you may be forced to negotiate with a hard-money lender, who often are private individuals loaning money from their pension plans.

And beware: Those loans are more expensive and often have more onerous terms than the standard mortgage backed by the federal government, Fannie Mae or Freddie Mac.

Who typically gets such a loan? If you have bought a house and haven’t yet sold your existing one, you might get a hard-money bridge loan. They are typically short-term. Other users are homeowners with bad credit but lots of equity in the home who want to avoid foreclosure. Unfortunately, from my experience, all too often the hard-money lender ends up owning the property.

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There are many legitimate hard-money lenders. However, as in every profession or industry, there are some bad apples. Some hard-money lenders are loan sharks whose sole objective is to take your house away from you.

If you need a short-term loan and decide to confront a hard-money lender, please have your attorney review all of the legal documents the lender will ask you to sign. You want the money, but you don’t want to lose your valuable home.

DEAR BENNY: We have a time share that we want to deed back to the resort, but they want $1,750 dollars to take back the deed. We are in our 70s and want to know if we can just give the deed back without paying the fee. Can they put a lien on our house? We don’t care about credit ratings, since we pay cash for everything. –Don

DEAR DON: You cannot just "give away" the deed. It has to be accepted by the resort and recorded among the land records in the county where the property is located.

If the resort will take back the deed and relieve you from any and all further obligations, I would jump at that opportunity. Obviously, I would try to negotiate a lower buyout or try to work out a payment schedule. However, from the many readers who have time-share problems, your situation is unusual.

I do want to comment about your statement that you don’t care about your credit rating. You may pay everything in cash and be a multimillionaire, but there may come a time when you will need credit, and a poor credit rating can, and will, haunt you for the rest of your life.

DEAR BENNY: I live in a 125-unit condominium. Recently, our board of directors signed a contract for almost $1 million to upgrade our elevators. I believe that the board did not get any bids and just went with one company. Is there any law requiring more than one bid on any one job, especially one as large as this? –Henry

DEAR HENRY: To my knowledge, there is no law on this subject; it’s really a matter of common sense. And in a community association, it may also be a matter of fiduciary duty.

If you lived in a single-family home and wanted to do major construction, I am sure that you would get at least two, if not three, bids on your project. You would meet with each prospective contractor, get references and make sure they have the appropriate licenses to do your job.

Why should this be different in a community association? Your board of directors is spending your money and it has a fiduciary duty to you (and all other owners) to be prudent. Accordingly, to just get one bid is, in my opinion, unacceptable and may actually be a violation of the board’s collective fiduciary duty.

Equally important, there is often suspicion on the part of owners that board members are getting kickbacks from the service providers. Clearly, just accepting the first bid adds to this suspicion.

I am not advocating getting the lowest bid all the time. You get what you pay for, and sometimes it would make sense — in the board’s judgment — to use a higher bidder. But obviously, if you have only one bid, you can’t go either higher or lower.

And there are situations where there is only one company in town that can do the job for you. In that case, the board cannot get more bids. If that’s the situation, then the board should document these facts and send a note to all owners about why it is not getting multiple bids.

Communication, in my opinion, resolves most, if not all, problems. Lack of communication, on the other hand, creates distrust and fights.

In your case, the board might want to retroactively get another bid just to satisfy its members — and you — that the current price is in the ballpark. Realistically, however, I doubt that any contractor would want to waste time preparing a bid knowing that it will never be accepted.

DEAR BENNY: Congress started removing some financial hazards of default when it enacted a law that temporarily waives the income tax on mortgage debt that is canceled when a homeowner is foreclosed upon, sells a home for less than the remaining debt (a short sale), or gets a loan modification that reduces the principal balance. The tax waiver originally applied only to debt on a primary residence canceled in 2007, 2008 or 2009. Last month, in the bailout bill, Congress extended the waiver until 2013.

Say you lived in your house as a primary residence from 2005-2007. Then because of economic hardships you rented out your house to a tenant in 2008 in order to pay the mortgage. If you are foreclosed on or do a short sale in 2009, do you still get the income tax waiver on mortgage debt that is canceled?

I already know of at least several people in my situation … before all these federal bailouts occurred in 2008, the only real economic recourse for saving their homes was to rent out their primary residences to tenants. But because of continuing declines in the value of the homes, many would just want to foreclose but aren’t sure if the tax waiver on foreclosures applies since the home is no longer their primary residence. –Kevin

DEAR KEVIN: You sent me this email a couple of years ago, and I did not get a chance to use your question. However, it now becomes timely, because when Congress enacted (on Jan. 2, 2013) the American Taxpayer Relief Act, it extended the law you are discussing through Dec. 31, 2013.

In general, as strange as it may seem, if your mortgage debt is canceled by way of a short sale, foreclosure or loan modification, the Internal Revenue Service calls this income and you have to pay tax on it. We call it "phantom income."

However, as you stated, Congress was concerned about this and in 2007, enacted the Mortgage Forgiveness Debt Relief Act. Oversimplified, if the debt that was canceled involved your principal home, up to $2 million of forgiven debt is eligible for exclusion ($1 million if married filing separately), i.e., you don’t have to pay any tax on the money you did not get. That law was to have expired at the end of 2012, but, as mentioned above, has now been extended through the end of this year.

However, this must be your principal residence. In your example, if you moved out and rented, for whatever reason, I am concerned that this is no longer your main home. Presumably, you declared the rental income on your tax returns, and even may have taken depreciation. So the IRS would not look kindly on your claim that this is your principal residence.

It’s not fair, but neither is the phantom income tax.

Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to benny@inman.com.

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