If the term "hard money" conjures up images of shady-looking loan sharks trading cash out of back alleys with sky-high interest rates, it's probably time to think again. In fact, hard loans are funded by reputable investors who specialize in helping cash-strapped businesses with their short-term borrowing needs. Hard money loans are much easier to get than conventional loans. So, if your bank says "no," a hard money lender may well say "yes."
What Is a Hard Money Loan?
Basically, it's a short-term loan secured by real estate. Real estate investors often use hard money to purchase and renovate a property before flipping it over for resale, and businesses often use it to fund a specific short-term project or as a bridge while they secure conventional financing. Ironically, given the name, hard money loans are the easiest to qualify for. A hard money lender will look only at the value of the underlying real estate asset, rather than the creditworthiness of the borrower when making a lending decision.
Who Qualifies for Hard Money Loans?
Anyone with equity in a real estate asset can apply for a hard money loan. The important thing is the value of the collateral you're offering relative to the amount of the loan, known as the loan-to-value ratio or LTV. So, if you need to borrow $150,000 and the factory you're putting up as collateral is valued at $200,000, then the LTV is 75 percent (15,000/200,000). Each hard money lender will have its own guidelines for the maximum LTV they'll fund, with a typical cut off somewhere around the 70 to 75 percent mark. The higher the loan-to-value ratio, the more difficult it is to get a loan.
Why Businesses Need Hard Money Loans
Businesses tend to look at hard money options when they do not qualify for a traditional business loan but need some extra cash to finance their operations. Hard money loans are much easier for startups and businesses with poor credit to obtain since lenders don't take your credit history, credit score or trading record into account. Another reason to choose hard money is when you need a cash injection, fast. Hard loans can close in as little as three days, thanks to their relaxed underwriting. They're a good solution for emergency needs and can tide your business over while your application for conventional finance goes through.
What Is the Difference Between Hard and Soft Money?
Soft money loans are loans with longer repayment terms and so-called "soft" or low-interest rates. They are qualified in a much more rigorous way than hard money loans, taking the borrower's credit score and trading record into account. A high credit score means you'll qualify for the best interest rates. Most soft money loans are secured loans which means you'll still need to pledge some collateral. However, many soft money lenders can fund up to 90 percent of your property's LTV, giving you access to a much larger pot of money.
Drawbacks of Hard Money Loans
Because they're riskier than conventional loans, hard money loans are typically issued at much higher interest rates. Typical rates start at around 7 percent and ratchet up from there with rates of 12 percent typical. You'll also have to pay 1-to-10 percent in lender's fees, known as points. There's a good chance the loan will be structured as a very short-term loan of, say, six-months-to-three years, with an interest-only monthly payment and a large balloon payment when the loan matures. As with any secured loan, the lender can foreclose on the underlying property if you fail to make the payments. You have to be fairly confident about your future cash flows and/or your ability to secure long-term financing to consider this type of loan.