Pause for a moment and think about it: What really comes to your mind when you come across the words ‘hard money loans’? A quick source of disposable capital with a few risky strings attached? Shady-looking pawnbrokers and lenders that thrive on charging exorbitant interest rates? Or is it a reputable banker in a neatly pressed suit?
Whatever the case maybe, one thing remains constant – the hard money lending industry has been around for quite some time now. It is also as highly misunderstood as it is practical and versatile. Therefore, it is important to clear the air by drawing a line between hard facts and mere conceptions. And here is a quick primer to that.
What Do Hard Money Loans Entail?
A hard money loan or private capital is just another definition of a soft loan that is secured by real estate collateral. [ https://en.wikipedia.org/wiki/Hard_money_loan ] This kind of short-term loans is typically funded/offered by private capital investors instead of conventional credit unions, banks or other regular financial institutions. The repayment time length often ranges from as short as 12 months to as long as 3 to 5 years, rarely does the loan term exceed 5 years. And just like an ordinary loan, servicing it requires regular monthly payments that include the principal amount and the slowly accumulating interest or, a chunk of principal every month finalized with a balloon payment towards the end of the repayment term.
Having said that, it is imperative to know that the amount of capital a borrower can secure through a commercial hard money lending process is primarily determined by the market value of the real estate property that they intend to use as collateral. The property in question might be one that the borrower is looking to acquire or real estate that they already own. Either way, unlike in traditional financing, potential borrowers who may not be in a position to access conventional loans due to recent foreclosures or a history of defaulting payments can still secure a hard money loan if they have enough equity in the collateral property.
What Types of Property can Qualify for Commercial Hard Money Loans?
All factors held constant; a potential borrower can secure a hard money loan using almost any variant of real estate: be it a multi-family residential, single-family residential, land, industrial or commercial buildings. However, commercial hard money loans – just as the name would suggest – are precisely limited to commercial real estate as collateral. Commercial real-estate space is often preferable over Residential by Hard Money Lenders. The reason for this is that a majority of such lenders like to cautiously stay away from the residential real estate due to the stringent regulations/rules that revolve around them. A majority of commercial hard money lenders will readily process your loan in 1st position. Fewer – the bolder ones – will be willing to wade through the paperwork and offer you a loan in 2nd position. It is riskier for the lender in the latter than in the former.
Types of Deals/Scenarios Suitable for Commercial Hard Money Loans
Ordinarily, commercial hard money loans are not recommended for all deals. For instance, if you or your business/franchise has a remarkable income history, healthy credit score, and there are no tentative issues such as a foreclosure or short sale looming in the air, traditional financing via a credit union/bank is typically the best option for an ordinary lender. Especially if you have the time and logistics patience to wait for the lengthy approval process before the funds are disbursed by the lending institution.
On the other end of the spectrum, commercial hard money loans are your ideal source of capital if;
- Banks and traditional financial services are not an option
- You need a hefty but urgent loan within a comparatively short period of time ( say within 48 hours )
That being said, commercial hard money loans can save the day in some of these situations;
- When in dire need of a construction loan
- To supplement an ordinary loan offered by a conventional lender such as a bank
- For fix and flips type of arrangements.
- When a smart real estate investor has to act fast to secure a prized/rare property gem.
Who Should Make Use of Commercial Hard Money Loans?
A variety of real estate investors, keen business people or commercial real-estate developers may choose to rely on commercial hard money loans for a range of contrasting reasons. For starters, the short time frame between application and disbursements of the funds is typically one of the most attractive feature of these loans. In fact, some private capital investors have been known to fund colossal loans within waiting periods as short as 72 hours . Now compared to the usual 20 to 30 days that a traditional lender such as a bank takes to approve relatively massive loans, commercial hard money lending is more than just a necessity in some people’s line of business. If anything, you can rule out doing any meaningful business, if you regularly need to borrow vast sums of money from a conventional lender.
Secondly, the ability to secure funding within such a remarkably short time frame – can even be within the same day of applying for one – proves to be a significant advantage for a competitive real estate investor. Particularly when one is trying to acquire prime property by outdoing competing bids by offering a lump sum pay off, as opposed to slow and gradual traditional financing. Sellers are generally partial to prompt lump sum cash payments and may even offer to give you a substantial discount in exchange for closing the deal within such a short time frame. In times such as this, a source of commercial real estate loans can make a difference of several tens or even hundreds of thousands of dollars for the smart investor.
Thirdly, a borrower who is not in good terms with traditional lenders will have no other choice than seeking the refuge of commercial hard money loans. And before you dismiss this as a distant impossibility, bear in mind that it doesn’t take much for a bank to reject your application for a substantial loan. Life is always full of surprises, one goes through the ups and downs. Things happen…foreclosures, short sales, ruined credit scores, etc. They all add up. They may also hamper your chances of being awarded that six figure crucial injection of capital that you need to take your enterprise to the next level.
That aside, it is common for conventional lenders to deny loan requests from firms with an insufficient income history. Therefore, if you have just started a new well-paying and promising job, your chances of securing a sizable loan from your local credit union or conventional bank are almost close to none. The same applies if you own a business that has only recently started making steady and reasonable profits. As much as you may be churning out a healthy income every year, a bank could still reject your loan application on the grounds of lack of a convincing income history. Commercial hard money investors, on the other hand, can look beyond this as long as there is a plausible assurance that the principal plus the interest will be repaid within the stipulated period. This assurance is often determined on the basis of commercial real estate collateral or reasonably invested equity on the property in question.
How are Points and Interest Rates Determined in Commercial Hard Money Loans Processes?
The points and interest rates charged by private capital investors – as you would expect – often vary from one lender to another. Reason being; many culminating factors revolve around the subject of commercial hard money loans. Private capital investors in California, for instance, typically have lower repayment interest rates than in other states as there are lot more commercial hard money lenders in California vying for one’s business, hence the favorable lending terms.
It goes without saying that hard money lending investors take on a higher risk funding these types of loans compared to traditional bank loans. As a result, the interest rates pegged on hard money loans are relatively higher than in regular bank loans. Numerically speaking, the interest rates for most commercial hard money loans can swing between 7.7 to 21%. [http://www.4smartmoney.com/10-key-facts-hard-money-loans/ ] The points, on the other hand, can range anywhere between 1% to 5% of the principal amount. There are no hard-&-fast rules on how rates and points would be calculated, only that the competition in the market where the commercial property is located and how much risk the lender would assume based on the collateral, are crucial determining factors. A very good indicator for what you will be charged is determined by the loan-to-value ratio.
But what is Commercial Hard Money Loan-to-Value Ratio?
The total amount that a private capital investor can lend is essentially calculated by the ratio of the principal divided by the total value of the asset acting as collateral. This is in short known as loan-to-value ( LTV ). A majority of commercial real estate lenders will offer a maximum of around 60 to 70% of the current market value of the collateral. Still, some hard money financiers opt to lend based on the estimated ARV ( After Repair Value ) of the property, that is, after the borrower has refurbished the property. Everything else held constant; this consequently creates a riskier loan – as seen from the lender’s perspective. The principal amount offered by the lender increases as the amount of capital from the borrower reduces. And the increased risk compels the hard money investor to peg a higher interest rate on his loans.
Having said that, there are a few commercial hard money lenders who calculate their interests based on a property’s After Repair Value and still finance the refurbishing costs. This may sound great from your ( a borrower’s ) perspective. But have it at the back of your mind that the points and interest rates of such a hard money loan will be much higher. Expect anything from 18% interest rate going upwards complemented with 6 or more points. [http://www.investopedia.com/terms/h/hard_money_loan.asp ], especially if the lender will fund the loan plus the rehab costs with little or no down payment from you, the borrower. But even then, at times such loans, despite these prohibitive interest rates, may prove to be worthwhile if they are channeled in such a way that they can still generate a reasonable profit.
Are there any Unique Borrower Requirements for Commercial Hard Money Loans?
As we have notated earlier, hard money lenders are typically mostly concerned with the amount of money a borrower’s collateral can fetch in the market. Otherwise, they will evaluate the equity a borrower has invested in a commercial property that can be used as collateral. That said and done, they are less concerned about your credit score, income history or nature of business. Issues on a prospective borrower’s record such as repeated short sales or a foreclosure can be ignored if they can raise funds to settle the loan’s interest.
It is a two-way street, nonetheless. The commercial hard money lender also ought to take into account the borrower’s future plan for the property, any upcoming refurbishing or renovations have to be accounted for before a loan agreement is drafted. Lastly, as a borrower, you have to present a practical loan repayment plan to the private money investor with sufficient details on how you intend to settle the debt. Sometimes this might be improving the newly acquired commercial real estate portfolio and then flipping it later on at a substantially higher margin than its original buying price.
The Bottom Line
Commercial hard money loans are increasingly becoming a staple in the fast moving, competitive and lucrative real estate market. In a bid to make the best out of these fast-rising commercial real estate prices, more and more investors are relying on private capital investors to bankroll their speculative exploits. The trend has also seen ordinary business persons turning to such seemingly unconventional sources of credit whenever they need a quick injection of capital into their enterprises. There are literally no-hold barriers here, and you can borrow as much as your investment collateral can allow. It is advisable to exercise a bit of caution, nonetheless. Commercial hard money loans not only carry a higher element of risk but also a bit more expensive to service.
In conclusion, resist the temptation to settle for the first private lender that you come across. Instead, shop around town for the best loan terms you can scour from established commercial hard money lending firms. You will be surprised at how favorable some of the rates can be. Otherwise, you can just start here and let us handle the rest for you.
