Real estate investors are the hard money industry’s main customers. Investors turned to hard money and bridge loans to get deals done quickly and with as little hassle as possible. This, despite the fact that hard money lenders typically offer lower loan-to-value (LTV) ratios, higher interest rates, and shorter terms.
So what is the deal? Why not go through traditional banks and avoid the higher rates in shorter terms hard money is known for? For many real estate investors, it boils down to a simple thing: W-2s.
As you probably know, the W-2 form is a tax form that shows an employee’s income and any taxes withheld. Traditional lenders rely on W-2s to establish a borrower’s income. It is how they determine how much a borrower makes while they seek to determine whether his loan request should be approved. This is a problem for investors.
Investors Have Nontraditional Income
A full-time investor whose income is derived solely from his investments has what some tax experts refer to as ‘nontraditional income’. It is not income that shows up on a W-2. Why? Because the investor is not employed. His income is derived from the gains he makes on his investments. Therefore, his income is described as ‘investment income’ or ‘capital gains’.
Capital gains are actually what full-time investors pay taxes on. It’s not income derived from a job. It is income derived from making profits on investments. Therefore, full-time investors cannot submit W-2s. In fact, they have no official government form they can submit to prove income.
Obtaining a traditional loan without W-2s requires mountains of paperwork to prove income. Banks want to see profit and loss statements, income tax records, and bank statements. They require borrowers to do everything possible to prove the income they claim. It is a lot of work on the borrower’s park.
Hard Money Lending Is Different
Fortunately, full-time investors have an option in hard money. Hard money lending is different by design. In fact, it’s so different that a firm like Salt Lake City’s Actium Lending will never ask for W-2s. They don’t need them. And in fact, they know their clients cannot furnish them anyway.
So how do hard money borrowers establish their income? They do not. Actium Lending and its competitors are not interested in that. Rather, they are interested in the piece of property being obtained with the requested loan. What is its value? That’s what lenders want to know.
The property is offered as collateral backing the loan in question. So the most important thing to the lender is that the property has enough value to cover the amount being borrowed along with any additional costs and a little bit of profit. If so, most lenders can find their way to approval.
A Different Way of Doing Business
Hard money lending is known as asset-based lending due to approval decisions being based on asset value. Note that asset-based lending isn’t shady or under the table. It is simply a different way of doing business. Also note that hard money lenders are private lenders. They have the freedom to be more flexible. They are allowed to establish their own lending criteria, even to the point of requiring that collateral back up a requested loan.
Full-time property investors don’t have W-2 income, which is why they struggle to obtain traditional bank loans. Without W-2 forms to submit, they are forced to offer a mountain of documentation proving their financial resources. The other option is to go to a hard money lender and offer a piece of valuable collateral. I know which option I prefer.
