What we would consider the traditional financial system crashed hard in 2008. Fueled by an unsustainable credit bubble and artificially high real estate prices, the system could not withstand the pressure of growing numbers of defaulting mortgages. The entire system came crashing down in short order. Some 12 years later, we are potentially on the verge of a similar crash thanks to COVID-19.
It is interesting to note that the alternative financial services market did not suffer the same fate back in 2008. And today, the market is shining brightly. From alternative payment processors to hard money lenders, this alternative market is stepping up and doing what their traditional counterparts cannot or will not do.
Banks are Scaling Back
One place to look for a more conservative approach is business lending. Banks, scared to death of where the economy might go, are overhauling their underwriting requirements in order to make borrowing more difficult. Until the economy recovers, they are not about to lend to anyone but the most stellar applicants.
Hard money lenders, on the other hand, are not slowing down to nearly the same degree. It is full steam ahead for the most part. So what’s the difference? Why aren’t they equally risk-averse with so much economic uncertainty?
A great piece by Marker contributor Byrne Hobart points out that the more complex a credit instrument is, the more likely that instrument is hiding risk. Take your traditional small business loan, for example. Banks go through an extraordinarily complex underwriting process to make such loans.
A bank will look at a borrower’s personal income, credit history and score, debt load, and other factors. It will take an equally hard look at the borrower’s business. All of these criteria go into determining credit worthiness. Yet the more criteria a lender looks at, the more room there is for risk.
A perceived strength in one area can make up for weakness in another. As the thinking goes, a more complex underwriting criteria allows banks to spread their risk across a larger area. Yet it only takes a single failure in one area of weakness to lead to default.
Hard Money Lending is Simpler
Hard money deals are a lot simpler compared to bank deals. When a small business wishes to borrow, it offers some sort of collateral as backing for the loan. In most every case, the collateral is real property. It doesn’t have to be though. There are hard money lenders that will take business machinery and equipment, accounts receivables, and other assets as collateral.
Regardless of the collateral, here’s the deal: the value and resale potential of that collateral is the single largest factor in determining whether or not a loan is made. It is no more complicated than that. A loan will be made as long as the lender feels the collateral warrants the risk. If not, the loan will not be made.
Relying on such a simple approval process puts the risk out there. It’s all on the collateral, therefore it is also plain to see. Hard money lenders are not complicating the process by looking at dozens of different criteria that only serve to cloud the picture.
Alternative Financial Products Work
Alternative financial products generally work as well or better than their traditional counterparts. They are designed to be that way so as to make them as widely available as possible. Those in the traditional financial sector may consider alternative products a last resort, but these alternative products actually offer a lot of value to customers. And that’s why alternative lenders are shining right now.