- A hard money loan, also known as a hard money bridge loan, is a financing option secured by a commercial real estate asset. It is used by real estate developers and property flippers looking to acquire a real estate property quickly.
- Hard money loans come with high-interest rates, which is why business owners usually consider them as a ‘last resort’ option.
Businesses may find themselves in need of a quick cash injection to cover time-sensitive business investments like acquiring or developing real estate properties. In such instances, a traditional commercial loan may take too long to secure due to the stringent approval processes. Furthermore, if your business has a poor credit score, your chances of qualifying for any small business financing drop significantly.
One of the most popular “last resort” options that businesses in such situations will usually turn to are hard money bridge loans. These loans are often utilized as a last resort for two reasons: business owners tend to apply for them when they aren’t able to qualify for traditional financing options; and because they come with high interest rates and fees that make them costly to pay back.
If used the wrong way, a hard money loan can actually cause financial strain, which is why it’s important to do your research before applying for one. In this article, we’ll do a deeper dive into the hard money loan to help you get a better understanding of what it is and how it can be used.
Hard Money Bridge Loan Overview
A hard money loan – sometimes called short-term bridge loan or hard money bridge loan – is a type of short-term financing secured by an asset, specifically commercial real estate properties. This type of loan is mainly used by real estate developers and property flippers looking to acquire land or a commercial property quickly while they seek or wait for approval for a long-term financial solution.
Once approved, the proceeds are then put towards developing or fixing the property to increase its value and eventually sell it at a higher price.
Hard money loans are a risky venture in general. That is why banks, which are notorious for being risk-averse, do not offer this kind of financing to anyone. Instead, business owners may have to look at private investors (individuals or companies) to secure a hard money loan. Private investors are not bound by the same regulations that large banks are, and therefore, are free to choose who they want to lend to.
Hard Money Loans Qualifications
One of the most important things to recognize about hard money lenders is that each of them may have unique eligibility criteria. However, these lenders generally consider one major factor when deciding whether the applicant is qualified or not: the value of their asset.
Since this form of financing is mainly asset-based, the terms for the loan will largely depend on the value of the asset you pledge, as opposed to your creditworthiness (though your credit history will still be considered). It’s worth noting that the asset used as collateral in the financing will most likely be the property you’re acquiring or developing.
The lenders will base your eligibility and terms for the loan on the loan-to-value (LTV) ratio, which is expressed as a percentage. Essentially, the higher the LTV ratio is, the riskier the lending arrangement is. In turn, the interest rates will also be higher.
Loan-To-Value (LTV) Ratio
The loan-to-value (LTV) ratio is the percentage of the property’s value, which lenders use to determine the risk they face by extending credit to a borrower. LTV Ratio is calculated by dividing the loan value by the appraised value of the property and multiplying the quotient by 100.
LTV (%) = (Loan amount / Appraised value of the asset) x 100%
Hard Money Loans Terms
Knowing the basic facts about hard money bridge loans, you may wonder what terms await you if you decide to move forward with your application.
The terms for the loan will ultimately depend on the type of lender you work with. But to give you an idea, here’s an overview of the terms that lenders usually grant eligible small business borrowers:
Loan Amount: At most 75% of the property’s total value
Interest Rates: 12% to 29%
LTV: up to 70% LTV ratio
Repayment Period: A few months to one year, although two- to three-year repayment periods are not unheard of.
What are the Advantages and Disadvantages of Hard Money Loans?
Hard money loans are viable solutions if you’re looking for a quicker way to access financing to acquire real estate. However, like other types of business financing, it’s not a one-size-fits-all solution to cash flow problems.
Let’s explore what good it offers to businesses as well as its possible downsides.
1. Immediate Cash Flow Boost
Businesses often turn to hard money loans if they find the application and approval process for traditional loans too lengthy and they need money quickly. Or, they (the borrower) may resort to hard money loans while waiting to get approved for conventional financing.
2. Easy to Qualify for
Business credit scores don’t matter much in the loan underwriting process. So long as you have a real estate asset to pledge, you’ll most likely qualify for a hard money loan. Since this loan type is mainly dependent on collateral, it’s highly sought-after by borrowers with less than stellar credit backgrounds.
3. Less Documentation Needed
Traditional business loans usually require applicants to provide extensive documentation when applying. This is not the case with hard money bridge loans, as the lenders primary concern is the collateral. The application process for hard money bridge loans is very straightforward and requires less documentation.
1. High-Interest Rate and Fees
Lenders who provide hard money loans face a higher risk as the borrowers who apply for this type of financing are typically less qualified (as mentioned, many resort to this loan type because they can’t qualify for a traditional loan). As a means to mitigate their risk, lenders will charge higher interest rates for the loan. Shorter repayment terms is another reason hard money lenders charge borrowers with a higher rate.
On top of the interest rates, hard money lenders may also charge loan fees, amounting anywhere from 2% to 10% of the borrowing amount.
2. Possibility of Losing Your Property
Plain and simple, hard money loans can be quite costly. This high cost can put you (the borrower) in danger of defaulting, especially if your business isn’t getting enough cash flow from month to month. If you aren’t able to pay the loan back, the lenders can seize your asset, as you will have used it as collateral for the loan. Some lenders may require you to pledge personal collateral for added security, in which case you’d not only risk losing your business property, but your personal assets as well.
Note: Start-up business owners lacking an impressive credit background typically opt for hard money bridge loans as they’re easier to obtain than traditional loans. However, they’re particularly at risk as hard money loans come with high interest rates and fees, which generally makes the loan more expensive. If they don’t get enough cash flow every month, they would have difficulty paying the loan back.
Hard Money Loans: Is It Worth It?
As is true with any type of outside financing, just because it provides you with the funding you need doesn’t necessarily mean it’s the best option for your business.
Before applying for a hard money bridge loan, ask yourself these questions:
- Do you need quick access to cash to take advantage of time-sensitive real estate deals?
- Can you afford the financing’s high interest rates and fees?
- Are you in the process of securing a long-term financial solution?
- Is your current credit standing preventing you from securing conventional business loans?
If you answer yes to all these questions, then it might be worth considering a hard money loan. The final decision will ultimately depend on your business’ current needs and financial situation.
Alternative Financing Options to Hard Money Loans and Bridge Loans
If you decide that hard money loans are not the best financing solution for you, here are some other financing options to consider:
1. Business Line of Credit
A business line of credit can be an excellent financial resource if your business needs continuous access to additional capital. Once approved, the lender opens a credit line with a pre-determined credit limit, which the company can use on an as-needed basis. As the business draws money from the credit line, the amount of credit available to them decreases. Once they’ve paid off the money they withdrew, the available credit returns to the original amount, and the business can re-access the same funds in the future.
With a line of credit, businesses with an excellent credit score can get up to $1,000,000 in funding. They can use the proceeds towards various business purposes, including:
- Investing in real estate
- Property renovations
- Buying office supplies and fixtures
- Debt refinancing
However, unlike hard money loans, business lines of credit will consider the business’ creditworthiness in the underwriting process. That said, to qualify for better terms, you must show a good credit score and healthy financial history.
2. Short-Term Loans
Short-term loans are one of the most accessible financing options in the market because they don’t require collateral. Additionally, alternative lenders are more willing to offer short-term loans to high-risk businesses (i.e., startups or companies that lack a strong credit background). Short-term loans also have a quick funding time, especially if you’re applying from online lenders.
Unlike a line of credit, once the business gets approved for short-term loans, they will receive a lump sum upfront. They can then use the proceeds for various business purposes, including business renovations and buying materials, supplies, and fixtures.
Short-term loans, as the name implies, typically have a short repayment period. In most cases, the term for the loan will range from three months to one year.
Frequently Asked Questions About Hard Money Loans
1. Are there unsecured hard money loans?
Unfortunately, there’s no such thing as an unsecured hard money loan. By nature, the loan is tailored around the collateral (the real estate asset), making it a significant consideration in the financing’s approval process. By definition, you won’t be able to find a hard money loan that doesn’t require real estate collateral.
2. Do hard money lenders require down payment?
The down payment requirement will depend on the lender you’re working with. Since most lenders are alternative lenders, they’re not bound by the same regulations as banks. Therefore, they can offer flexible funding terms if you negotiate with them.
Some lenders may require down payments, while others may not. Lenders will usually look at your business’ eligibility before deciding whether or not they will require you to make a down payment.
3. Are there prepayment fees I should be aware of?
Again, every hard money lender handles loan underwriting and terms differently. That said, some lenders may charge a prepayment penalty, while others may not. The key is to ask the lender upon application if they charge one or not. Also, before signing, be sure to study and review the contract and try to see if there are prepayment penalties you should be aware of. If possible, ask your business attorney to help you in checking the loan agreement.
The Bottom Line
Hard money bridge loans can give you the cash flow boost you need to invest in real estate properties while you wait for a more comprehensive and long-term financial solution. However, it does come at a cost. Be sure to review what hard money loans are, especially the rates, before deciding to move forward with the application.