Despite interest rates dropping across the board from Treasuries to 30-year mortgage rates, hard money interest rates have been rising during the first forty-five days of the COVID-19 pandemic.

FCTD has had dozens of conversations with our borrower clients, Realtors, and mortgage brokers over the past month about terms, including interest rates, points, fees, etc. The majority of people expected that since interest rates are lower everywhere else, that hard money interest rates would have fallen rather than gone up.  They are surprised that hard money interest rates went the other direction.

Why are hard money interest rates going up?

Economic Uncertainty Due to a Lack of Testing

The first reason for the increase in hard money interest rates is the uncertainty over the depth and duration of the COVID-19 pandemic. Lenders do not know how long the economy will be shut down by the coronavirus. According the Wall Street Journal, “business leaders have told President Trump that his administration needed to dramatically increase the availability of coronavirus testing before the public would be confident enough to return to work, eat at restaurants or shop in retail establishments.”

However, at the moment, testing is still not readily available.

The New York Times reported, “Although capacity has improved in recent weeks, supply shortages remain crippling, and many regions are still restricting tests to people who meet specific criteria. Antibody tests, which reveal whether someone has ever been infected with the coronavirus, are just starting to be rolled out, and most have not been vetted by the Food and Drug Administration.”

At this point, in mid-April, nobody can get a good idea when testing will be available. The president’s daily press briefings are not providing information about testing nor are the briefings providing any insight into when the economy can open up again.  As hard money lenders look at the coronavirus situation and see a lack of factual information coming from the White House or a realistic blueprint that the country will mobilize to meet, like the buildup to World War II, they have to prepare for the downturn lasting eighteen months with starts and stops rather than being optimistic about three months of forced shutdown.

Loans Will Be Stay on the Books of Lenders

The hard money lenders that are still making loans at the outset of the COVID-19 pandemic are made by lenders that will retain the loan on their books, known as a portfolio loan, rather than selling the loan to investors in the secondary market.  For a lender making a loan, even at a loan at a lower Loan-To-Value (LTV) than they had been making the past five years, say 50% LTV today rather than 65% LTV back in 2018, they have to expect that economic conditions will further deteriorate and that 50% LTV loan today may wind up at 80% LTV by August 2021 if real estate values deteriorate.

These portfolio loans made today carry extra risk of loss that hard money lenders didn’t price into their loans from 2013-2019.  Real estate values were appreciating each year as the economy was improving, driving unemployment rates down to record lows.

By contrast, during the last thirty days since stay at home orders were issued, over twenty-two million people have filed unemployment insurance claims, taking the unemployment rate up from approximately 3.5% to nearly 20%, with unemployment expected to stay above 10% through the remainder of 2020.

Hard money payment forbearance requests are also already on the rise. Lenders expect to have more forbearance requests through the remainder of the year as tenants cannot make rent and real estate investors may have liquidity shortages, making it difficult to service the monthly debt payment. Hard money lenders are factoring future forbearance activity on existing loans in their portfolios and for new loans originated during COVID-19.

In addition to forbearance of monthly payments, lenders expect to have more loans go into maturity default when the balloon payment comes due on their bridge loans as borrowers are not able to sell their property due to the slowing real estate market or not able to refinance into bank financing, as mortgage credit becomes more difficult to obtain as banks set aside more reserves for future loan losses or conduit lenders cannot sell loans into the secondary mortgage market.

With these numbers pointing toward further economic deterioration before things start to improve, portfolio hard money lenders are taking precautions and pricing in the expected risk of defaults, forbearance measures, falling real estate values, and uncertainty in the mortgage credit markets into their interest rates on new loans. All signs point to more trouble ahead before we see improvement, so it’s best that real estate investors, Realtors, and mortgage brokers know that hard money interest rates are rising even though interest rates everywhere else are falling.