A Definition of Asset Based Lending
Asset based lending in real estate finance, also referred to as equity based lending, involves extending a loan that is secured by real estate assets. These assets can include commercial, residential and industrial properties, as well as land. For asset based mortgage lenders, the main criteria for loan approval is the value of the real estate, as well as the amount of the down payment (or equity in the case of a refinance transaction) the borrower can apply toward the purchase.
To say it another way: in asset based lending, the focus is on the collateral and not on the borrower. In contrast, conventional lenders, such as banks and credit unions, are more concerned with the borrower’s credit record and income.
In addition, since the lender is generally either an individual or a company specializing in asset based loans rather than a bank or credit union, these kinds of real estate loans are often referred to as “hard money loans.”
Advantages of Asset Based Lending
One of the great advantages of asset based real estate loans is the speed with which these transactions can be completed. Since the focus is on the value of the real estate or the owner’s equity in the property, asset based lenders are able to fund loans much faster than conventional lenders. This emphasis on value or equity allows lenders to place less emphasis on issues such as faulty credit scores, insufficient income and other blemishes on a borrower’s record.
The different criteria for extending an asset based real estate loan also means a vastly reduced amount of paperwork, another factor that helps expedite the lending process. Where a bank would probably require more than a dozen pieces of documentation before extending a loan, hard money lenders usually require no more than five or six pieces of documentation before signing an asset based lending agreement. These would include the contract to purchase the property (if applicable), personal identification, a title report, proof of rents and funds to purchase, an appraisal, and, possibly, a credit report.
An additional advantage is that because asset based lending for real estate is often structured as a line of credit, borrowers only have to repay if they actually draw on that line of credit. In contrast, term loans from a traditional lender must be repaid in full with interest, whether the loan is used or not.
Incidentally, this choice to use or not use borrowed funds as circumstances warrant, makes an asset based loan a great option for a company that may have intermittent needs, such as investing in additional inventory during a busy season and supplementing payroll during a slower season.
The Disadvantage of Asset Based Lending
Interest and fees comprise the greatest disadvantage of asset based loans. Asset based interest rates are higher than those charged on long-term loans extended by conventional lending institutions and usually range from a low of 7% up to around 17%. While the interest rates are higher, it is essential to remember that asset based loans are intended for short-term use only. The speed of approval and the funding provided by an asset based lending agreement, as well as the flexibility of the lending criteria, make up for the higher interest rates. Fees on the loan can be higher as well, depending on the type of loan being sought.
Real Estate Investors and Asset Based Lending
Many real estate investors utilize asset based lending to obtain fast approval and funding with relatively few requirements and documentation. If necessary, an asset based lending agreement can be worked out in a matter of a few days, whereas securing that same loan from a bank could take 2 to 3 months for the approval and funding process to be fully completed.
New Home Construction and Other Projects
Asset based lenders also provide funds for new home construction to contractors, often allowing them to borrow up to 60% of the land value and 100% of the construction costs. Plus, for escrows over a certain amount – $100K, for example – the borrower will only be required to pay interest on the funds as they are drawn.
In addition to new home construction, asset lenders often fund a variety of other projects. These include fix-and-flip loans, bridge loans, purchase loans, cash out and refinance loans, investment property loans and distressed property loans secured by real estate.
Asset Based Lending for Primary Residences
Very few asset based lenders provide primary residence, consumer purpose loans. The reason: Consumer purpose loans are subject to additional government regulations, require more licensing and involve a more extensive underwriting process.
The exception to this generalization regarding primary residencies is that asset based lenders may consider short-term loans to borrowers with a reasonable financial exit strategy. The borrower must be in a position that will allow them to refinance into a long-term conventional loan in the next 1 to 3 years.
As we have written in previous posts, an attorney is not required to negotiate, draft or close a real estate transaction, but you may still find professional legal assistance to be highly beneficial. While asset based loans can usually be completed in a shorter time and with far less paperwork than a conventional loan, they are not without their complications. Thus, you may consider hiring an experienced attorney to guide you through the process, from structuring the transaction and negotiating term sheets to completion of the closing process, to make sure everything is done correctly and to your satisfaction.
