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Behind the Numbers | Understanding Interest Rates in Hard Money Lending

The most common misconception about hard money loans is that they are risky. I cannot speak for the entire hard money lending industry – but I can talk for Ignite Funding. Offering risky loans is not in anyone’s best interest.

Our underwriting standards average from 60 to 75 percent of the loan-to-value, which reduces the risk but does not remove it from the equation. The risk is the borrower not making their interest payments.

Why do borrowers not make their interest payments? In my almost 20 years of experience, when a borrower has not made their interest payment, it is for one of these reasons: they have overextended their entire company financially, hired a CFO that mismanaged funds on a project, or they did not get the project started promptly, and ran out of funds to complete the project, or attempted to play the game of strong-arming because they are unable to make their payments unless the interest rate is reduced.

None of these reasons can be avoided through the underwriting process. Ignite Funding is an asset-based lender, with our number one priority being the property's value based on the amount lent. This is not to say the borrower's financials and track record are not necessary to review – because they are.

The exit strategy is the second priority to the asset's value to the amount lent. Why is the exit strategy after value? Because Ignite Funding needs to determine if the loan we are extending to the borrower allows the borrower to make a profit. If our origination fee and interest rate devour the return, then the probability of the borrower having a desire to complete the project is slim and, therefore, the loan carries a high degree of default risk.

Let’s talk interest rates because this has been a hot topic since rates started to creep up in 2021. First, we should consider the history of interest rates. In this illustration, we will look at the 30-year mortgage rate every ten years starting in 1973 - 8.04%, in 1983 – 13.24%, in 1993 – 7.17%, in 2003 – 5.89%, in 2013 – 4.16%, and in 2023 7%. The average in this illustration over the last 60 years is 7.6%.

While we can guess based on historical data, no one knows what will happen to mortgage rates. The economy and housing market are cyclical, experiencing ups and downs. The one interest rate that has not changed in Ignite Funding’s history is the rate we charge our borrowers – which is something a borrower can depend on.

Whether you consider the lowest interest rate in this 60-year historical period of 3.15% (2021) or the highest of 16.64% (1981) – Ignite Funding’s rate has not changed. Boy oh boy, did I take some heat from investors about this. Why no change? Just because others follow the trend, doesn’t mean we should.  We are trendsetters. Increasing interest rates in a volatile market adds risk to our investors and borrowers, which is a losing proposition that I am unwilling to take. Our low default rate speaks for itself.

When you get past the evaluation of the assets and exit strategy, what is left is maintaining a solid working relationship with the borrower. You do this by being consistent with funding deadlines, not changing the interest rate because it is trendsetting, and maintaining good communication with borrowers in good and bad economic times.

Good relationships with Borrowers and Investors are what the foundation of Ignite Funding has been built upon. Messing around with interest rates just to follow a trend isn’t a risk I am willing to take.

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