In early December 2015, JP Morgan announced a strategic partnership with OnDeck Capital, an alternative lending company, to originate, underwrite, and distribute loans specifically targeted at small businesses. The news shocked the banking world, as evidenced by a 28% single-day rise in OnDeck’s share price and has long-term implications for alternative lenders, of which hard money lenders are a critical part. .

The association scared many private lenders into worrying that major banks might be thinking of taking over their domains. JP Morgan’s association with OutBack seems to indicate this. The banks are already wide. Are they also going to take care of the alternative loans?

On the one hand…

Banks, like JP Morgan, have clear advantages over direct hard money lenders. And they know it. These include the following:

Product construction. The biggest names in traditional lending institutions, like Charles Schwab or Bank of America, can afford to give customers long-term loans and lines of credit that sometimes extend to five or more years. By contrast, alternative out-of-pocket lenders can only make loans that are limited to three years at best. These suit people who are desperate for some kind of money, even if it is short term. Banks have the advantage that their loans last longer at cheaper rates. Also, some major banks (such as Wells Fargo) have recently launched evergreen loans with no maturity date. This makes it more difficult for direct hard money lenders to compete.

Great interest. Hard money lenders charge notoriously high lines of credit – think somewhere in the 70-80 percent range. Traditional banks, on the other hand, half of this. To put that in perspective, consider that one of Bank of America’s basic small business credit cards (MasterCard Cash Rewards) has an APR range between 11 and 21 percent, not for a term loan or line of credit, but for a credit card! Alternative money lenders may market their business by touting its impressive speed and efficiency, but it’s the high interest factor that deters potential customers. And once again the banks have the upper hand.

Borrower risk profile. Banks only accept applicants who are convinced they can pay. Banks look at your credit history and FICO score to determine your worth. Hard money lenders, on the other hand, get their business by taking on the most tax-risky cases. As a result, and unsurprisingly, hard money lenders have a median default range of 16% and forecasters predict that many more borrowers will default in 2016 as prices stretch further. In short, it can be said that banks store the ‘cream of the crop’. Hard money lenders, on the other hand, tend to take the ‘cream of shit’ (because those borrowers are the ones who usually don’t have a choice) and sometimes, though not always, lose accordingly.

Macro sensitivity. Just yesterday (December 16, 1915), the Federal Reserve issued its long-awaited interest rate hike. The increase is negligible (from a range of 0% to 0.25% to a range of 0.25% to 0.5%), but adds to an already onerous private lending interest rate. The slight increase may add little to the impact of the banks. It adds a lot to the already high interest rate of the private lender.

Further…

Above all, banks have access to a wealth of data that private hard money lenders lack. The data banks include the years of experience and the libraries of accounts, expenses and risk data. Therefore, they can write credit with more predictive certainty and confidence.

Banks also have diversification and connection to each other. They are a homogeneous body with access to shared information. Hard money lenders lack this. In theory, they cannot assess the creditworthiness of a single borrower based on metrics captured from a variety of products offered by the bank.

On the other hand…

This is not to say that banks are going to dominate the hard money lender industry and capture your business. Hard money lenders have been successful as evidenced by their growth and the industry is becoming more and more stable. Tom SEO of TechCrunch.com predicts that unconventional lenders (hard money lenders among them) will survive and may even thrive. This is due to three things that are happening right now:

  1. Hard money lenders reduced their loan-to-value (LTV) levels – that’s huge. Until a month ago, one of the things that scared potential borrowers the most was the low LTV ratio where borrowers received a pittance for their property (as low as 50-70%). More recently, competition pushed lenders to stretch it to 80%. Some offer full percentage rates. This has gone a long way in increasing the attractiveness of the hard money lending industry.

  2. Technology: Technology helps with online directories that rank lenders based on locations, loan offers, rates, and prices. Aggregation triggers bids that spur lenders for convenient, fast terms and sometimes more reasonable prices. The Internet also helps hard money lenders in the sense that it helps them investigate a client’s background. Banks may have access to valuable treasure troves of data. But Google (and other engines) give lenders access to unprecedented resources. These resources improve over time. Private lenders use these data resources to guide their transactions.

  3. Alternative lenders that create full-service solutions will survive. Tom SEO believes that private lenders who offer a “one stop shop” for all kinds of banking needs will hit the mark. By offering a range of products and services that are compatible with traditional banks, while at the same time avoiding excessive overhead and maintaining operational efficiency, these private, hard-money lenders could carve out their own niche and displace test banks. for a certain population.

In shorts…

So if you’re a hard money direct lender or thinking of becoming one, the future isn’t all bleak. Banks, like JP Morgan, may dominate right now, but they will never displace you. You offer advantages that they don’t have and people need you.