Considering a fix and flip loan with a hard money lender? Think carefully about the double-digit interest rate before signing on.

Q: I enjoyed reading your story about on how distressed property REO investments may undermine housing markets. I am the marketing director at a leading hard money lender to residential real estate investors in the southeast.

We provide loans to individuals and entities who flip houses and often capitalize on foreclosure inventory–the “fix and flip” folks mentioned at the end of the article. However, we have found that the majority of our clients are selling the rehabbed homes to homeowners rather than renting. They are able to get excellent returns on their projects and also strengthen the surrounding communities.

While we do see the other side of fix-and-flip to rental properties in the market that was discussed in the article, I thought that the opposite site was worthy of discussion.

Thanks. I enjoyed the article!

A: Thanks for your email. For those readers who haven’t come across this sort of lender, hard money lenders lend to investors who typically can’t qualify for a loan with an ordinary commercial mortgage lender or who receive more advantageous loan terms but at higher interest rates and costs.

Hard money loans are typically provided at extremely high interest rates, accompanied by higher (sometimes very high) points (a point is one percent of the loan amount) and fees. While you might imagine a hard money lender being somewhat unsavory in character (a characterization created from film and television depictions of the industry), there are, in fact, hard money non-profit trade associations, such as the National Hard Money Association and the American Association of Private Lenders, which welcomes hard money lenders in its ranks.

Still, the industry is subject to far less regulation than the secondary mortgage market run by Fannie Mae and Freddie Mac. And if you’re thinking of getting a hard money loan, beware. While there is a legitimate use for hard money lenders in some commercial transactions, they’re a quick route to bankruptcy for many residential real estate investors who may not be prepared to make payments on a loan carrying credit card interest rates.

Now, to your question: Right now, there is such a high demand for properties from buyers that we’re not surprised that your clients are selling their properties. A lot of companies in a wide variety of industries are selling everything they own.

Of course, with hard money lending, we’re also sure you’re charging interest rates far above 3.5 percent for a 30-year fixed-rate mortgage, with plenty of points and fees added on top of that. Your clients are probably paying double-digits for their loans, and are looking to unload the properties and pay off the mortgages as quickly as possible.

But hedge funds, private equity players and other bigger investors seem to be utilizing a buy and hold strategy. It will be interesting to see how they unload these properties over the next few years and what happens to local markets when they do. A lot of their buying took place in the southwest and southeast, in markets that were extremely damaged in the housing crisis. Many of these markets have not yet recovered.

It would be difficult to sustain the cash flow necessary to pay off a loan with a 20 percent interest rate, for example. This is why investors try to get these loans paid off as quickly as possible.

Thanks for your comment.