Hard money loans are well vetted by trust deed investment companies (TDICs) and are underwritten by both TDICs and the lenders themselves, but that doesn’t mean they are guaranteed and without risk. The risks associated with hard money loans are referred to as “hair” of the loan.
Hard Money Hair
Hair can consist of many things including the risk that the borrower could default on the loan, their exit strategy could fail, property values could drop, or that the property might have damage or problems undetectable by visual inspection—like mold or foundation issues.
Other hairy factors could include a difficult borrower, or tangled circumstances surrounding a particular loan request that make underwriting more than a little difficult. This can include a borrower who needs his or her funding very quickly—meaning that underwriting and paperwork processing must take place in an extremely tight period of time, a borrower unable to raise the necessary cash for the difference between the necessary capital and the loan amount, borrowers who are nervous about committing and don’t pull the trigger on the loan despite going through all the motions and those who have no concrete exit strategy for the loan.
Like a knot in a huge head of hair, each of these circumstances must be gently coaxed and smoothed by the trust deed investment company in order for the deal to be finalized and the loan issued.
Hedging against Hair
When considering any potential investment, one must not focus strictly on return, but must also consider preserving their capital and hedging it against risk. It is rare that an investment vehicle delivers both protection from its own inherent risks as well as an impressive return, but trust deeds are one such instrument.
The protection against risk (or hair) comes in the form of the trust deed investment company (TDIC) who acts as an in-between, thereby cushioning the investor from the idiosyncrasies of a potential borrower. When the hair represents a financial risk, the hedge comes from the protective equity in the loan, the intrinsic hedge within the trust deed arrangement. The protective equity is the quick sale value of the home, minus any loans, liens and costs associated with recapturing the principal after default.
Just like in life, hair is a natural—if bothersome—part of the trust deed process. Luckily for the investors, TDICs and protective equity exist to make the hair a little less… hairy.