Three months after he retired from his Wisconsin packaging business and moved to California, Don Passehl watched the bottom fall out of the stock market, seriously depleting his retirement savings. It was enough to prompt Passehl and his wife to look for a better, safer place to invest their money.
That was 2008. Passehl, now 61, of Laguna Niguel, is rebuilding his nest egg by lending to real estate investors so they can buy foreclosed homes in Inland Southern California. He is pleased to be getting a 9 percent annual return by lending on deals that banks would reject.
In Riverside and San Bernardino counties, as across the nation, mortgage experts say they have seen a surge of interest in so-called "hard money" loans because they generate income that is far higher than what is available from the rock bottom interest rates of bank CDs and more dependable than a gyrating stock market.
Among the investors eager to do hard-money lending -- charging interest rates of up to 12 percent -- are retirees and pension funds.
On the receiving side of the loans are borrowers wanting to take advantage of the real estate downturn to buy what they consider bargain-priced homes they can fix up and hopefully resell at a profit. They are willing to pay high interest rates for money lent by private individuals at a time when lending standards have tightened and they cannot qualify for less expensive bank loans.
"There really isn't any good or liquid financing available for investors through conventional channels," said Guy D. Cecala, publisher of the trade publication Inside Mortgage Finance.
Increased Prevalence
Cecala said a sharp increase in hard-money lending is linked to the collapse of the subprime market and the federal government's expanded role in real estate financing, which has given owner occupants preference over real estate investors.
He estimated that hard-money loans nationally will account for about 1 percent of the 5.5 million mortgages expected to be originated this year.
Hard-money loans are less dependent on the worthiness of the borrower and more dependent on the value of the assets serving as collateral than bank-generated real estate loans, say the experts. Here's how it works:
To protect their principal against a drop in real estate prices, hard-money lenders generally will lend no more than 65 percent of the appraised value of the property that is collateral for the loan.
In exchange for the loan, a hard-money lender receives a first trust deed on the property, tantamount to a mortgage, which means the lender can foreclose and take possession of the property if the borrower fails to make payments.
The real estate investor gets a hard-money loan for a year to buy a house, make repairs and then quickly resell it. The investor must make monthly interest payments to the lender until the house is sold, when the principal is also repaid.
Loans that real estate investors get to buy homes to keep as rentals before reselling them are structured for a number of years, with interest and principal paid monthly or with monthly interest-only payments and a balloon payment at the end.
"The attraction is a high rate of return for investors, but there is risk associated with that. There are no guarantees that the underlying properties won't decline in value or that because of high unemployment there won't be rents to support the loans," said Tom Poole, spokesman for the California Department of Real Estate.
