If your business is in a position where you cannot qualify for a traditional business loan but you need money to complete a project or for another reason, a hard money loan may be a route you can take. Hard money loans are non-traditional, alternative sources of small business financing.
Hard Money Loans
A hard money loan is a risky asset-based loan used by companies that cannot qualify for other types of loans to finance their operations. If a project comes up in which a small business wants to invest or if a company has used up their lines of credit, they can turn to hard money loans for their needs. Hard money loans are placed with private investors, banks, mortgage companies, and even the Small Business Administration. Hard money loans, for small businesses, should be used only for emergency needs due to their high interest rates.
How to Qualify for a Hard Money Loan
Hard money loans are not based on the creditworthiness of the borrower. Instead, they are based on the collateral you can offer to the lender. Your credit score is not usually considered. Only the collateral you can offer the lender is considered for a hard money loan. Usually, the entire value of the collateral is not used. Instead, a loan to value ratio is calculated for the hard money loan. The loan to value ratio is a percentage of the property's value. If the collateral you offer for the loan is not enough to secure the loan, you may have to offer up personal assets to secure the loan.
Loan to Value Ratio
A loan to value ratio for a hard money loan is calculated as loan value/appraised value of the property. The higher the ratio, the more difficult it is to get a loan. Usually, hard money lenders loan only about 70% of the value of the property. The loan to value ratio is a measure of risk for lenders.
Here's an example. Let's say that XYZ Company wants to take advantage of a project that costs $125,000. They need to borrow $90,000 in order to invest in this project, but can't get the money from any traditional lender. They approach a hard money lender who calculates their loan to value ratio. Their ratio is $90,000/$125,000 = .72 = 72%. Depending on the guidelines imposed by this particular hard money lender, they may or may not loan 72% of the value of the property. If they do not loan 72% of the cost of the project, XYZ Company can approach another hard money lender.
Interest Rate and Other Terms on a Hard Money Loan
Interest rates are higher on hard money loans than they are on traditional business loans. The reason is that hard money loans are riskier than traditional loans. The other terms on a hard money loan are also less favorable than on traditional loans.
Interest rates may start at around 12% and go all the way up to 29%. Small businesses also usually have to pay 4% - 8% in points. 70% loan to value is usually the maximum loan to value ratio a hard money lender will accept. A balloon payment may be required somewhere along the way. The term of the loan is usually short - as short as 1-5 years.
Hard Money Lenders
Hard money lenders are individuals or companies that have funds available for investment. To be a hard money lender, they have to be flexible and able to move quickly to take advantage of lending opportunities in the marketplace. They are not restricted to the rigid criteria of traditional business loans and traditional business sources.
Although you may have to go through several hard money lenders to find one that suits your needs, all you have to do is a simple search on the Internet to find hundreds of companies that engage in hard money lending.