Under the right circumstances, a hard money loan can provide borrowers with the funding they need to close a commercial real estate deal quickly. It’s easy to see why this type of financing is becoming increasingly popular, especially in this challenging lending environment that has made banks even more conservative.
Hard money loans have become a mainstream source of alternative financing. These loans offer many benefits, including credit availability, higher returns on investments, and asset-based underwriting.
In addition, the private capital market has also seen considerable growth. As a result, more lenders now offer hard money loans to cater to a growing number of borrowers seeking them for commercial investment property.
But despite its popularity and the many clear benefits it offers, the hard money loan is still shrouded in mystery. Many borrowers remain skeptical about this type of financing. It is riskier because lenders in this area don’t have formal acceptance and application processes. Interest rates are also higher.
Nevertheless, all types of commercial real estate funding have their pros and cons, and in the end, the successful investor can weigh these up. If you’re interested in taking out a hard money loan for your next commercial property deal, it’s important to lay out the facts and disprove the myths about hard money loans.
Don’t be put off by the stigma surrounding it. Here are six fallacies about hard money lending—and the truth about them.
Some people think that only borrowers who don’t qualify for traditional financing approach Commercial hard money lenders. There’s a notion that these loans are reserved for borrowers who are about to lose their properties and desperately need funds at whatever cost. And this is not true.
While some borrowers do use hard money loans as a last resort, there are several other reasons investors turn to this type of financing. For example, most borrowers who take out a hard money loan choose to enjoy faster closing times and more flexible terms.
Hard money loans are so much quicker than bank loans, making it attractive for those who want to flip commercial properties and those who need to close time-sensitive deals quickly (before the competition can beat them to it).Hard money loans can sometimes help refinance, too.
It is also widely used by veteran investors as short-term commercial bridge loans to fund their projects while selling another property. It can be an excellent stopgap measure for borrowers who need to maintain cash flow until their other property is sold.
Hard money loans indeed have a higher price tag because of the hefty interest rate, but their investment returns matter to most borrowers. And hard money often wins in this regard.
Think about it. When you take out a traditional loan, the bank will likely only finance up to 65% of your project’s total cost. This means having to come up with the remaining 35% and tying up much of your capital into the project.
When you take out a hard money loan, it’s possible to raise as much as 90% of the project’s total cost, leaving you with more disposable capital to use however you please. The interest rate might be higher for a hard money loan, but the return on investment is also often higher. You also invest less of your funds.
So is it true that hard money loans are expensive?
Yes—they do cost more upfront. But the shorter terms and lower zero prepayment penalties give borrowers the ability to pay the loan off faster with less money going into interest. These perks often make hard money loans less expensive compared to traditional loans overall.
Another misconception is that this type of financing ‘takes advantage of the borrower. Some naysayers even say that hard money loans are ‘traps’ that are impossible to escape.
Is there any truth to this myth? It depends on the quality of the lender you are working with.
An honest and reputable lender will make sure that you understand the terms of the loan. This is because they believe that clear and straightforward financing terms are crucial for building lasting relationships with borrowers.
Indeed, interest rates are higher with hard money loans, but the loan terms are flexible and spelled out.
Good lenders also want to ensure that you have an exit strategy. They want to know precisely how you will repay the loan so that they can get their money back. If a lender doesn’t ask about your exit plan, don’t work with them.
A suitable lender will always want you to demonstrate a solid exit strategy before giving you money, whether you plan to flip a commercial property, refinance it, or rent it out.
This could not be farther from the truth. Banks are harder to deal with because they have standardized processes. These processes are also highly rigid. Most banks don’t even provide financing for construction and development. They have to follow regulations and can all only provide loans based on specific rules.
Additionally, banks underwrite loans based on the income of the borrower. Therefore, they always want to minimize their exposure and often work only with commercial investment property investors that they already know.
This is not a problem with hard money. Hard money loans can be completed within 30 days.
Underwriting only takes 48 hours (sometimes less if the lender has successfully worked with you before). The terms of a hard money loan can also be altered or modified as your project progresses.
That said, it’s not true that you don’t need any documentation to get a hard money loan. Most lenders will still ask for essential documentation to assess your application and decide if you’re qualified. This is especially true if you are a first-time borrower.
Hard money lenders are in the business of assessing risk. Their goal is to be paid back. After all, they are lending out their own money, which means that they will not approve a too risky deal. In addition, they understand the commercial real estate game and have access to the tools and information to determine if the market can support the loan.
Is it risky for a borrower to take out a hard money loan? If you think you can abide by the terms and make the payments as scheduled, then there is no additional risk involved in taking out a hard money loan compared to taking out a bank loan.
Because of its notorious history, hard money is often associated with loan sharks. But this is no longer the case. This type of financing has become more mainstream. Many large, highly professional, and well-established hard money lenders are now competing with the big banks for your business.
Don’t let yourself be deterred by the myths surrounding hard money loans if you think it’s a good fit for your project. Instead, talk to a commercial financing expert if you need more guidance.
