How do Hard Money Loans for Small Businesses Work?

30 May, 2016 / Comments: Comments Off on How do Hard Money Loans for Small Businesses Work? / By

Money does not always have to come from a bank in order to fund a business. Those businesses that cannot get a standard loan are not out of luck; they just need to go alternate routes, such as hard money loans. These loans are funded by private individuals or companies that have the money to lend out to people that run a small business and have collateral to provide in the event that they stop paying on the loan. The process of obtaining a hard money loan is much simpler than going through the underwriting department at a traditional bank – individual lenders can set their own requirements and make changes as they see fit. There are no governing rules on this type of lending, which means that lenders can make and change rules as they go without the risk of getting in trouble.

 

Credit Is Not an Issue

One of the largest problems new small businesses have when trying to get a loan is their credit; they either do not have any or it is not very good. This is typical for most new businesses as they try to find the right balance between their revenues and expenses. With hard money loans, the credit score or history of a business is not as important as the amount of collateral they have to put up for the loan.

 

Determining the Value

What potential hard money lenders want to know is the value of the collateral you have to put up for the loan. Just as is the case with a mortgage, you have to have collateral that will at least equal the amount of the loan. If the assets your business owns do not equal the value of the amount of money you need from the lender, you will have to add personal assets to the pot in order to qualify.

 

Higher Interest Rates

It goes without saying that interest rates are going to be higher on hard money loans. This is because of a variety of reasons; the largest being that it is not a traditional loan from a standard bank. Due to the fact there are fewer regulations regarding this type of loan, lenders have the ability to charge much higher interest rates in order to make up for the level of risk you provide.

 

More Costs

Again, because hard money loans are very risky, the lenders do what they can to make their money upfront. This is done by charging points on the loan. Just as is the case with a mortgage loan, the points are a percentage of the loan amount. For example, if the lender charges you 4 points on a loan, you will have to pay 4% of the loan amount up front.

 

Defaulting on the Loan

If you default on the hard money loan, the lender has a backup plan – they take possession of your collateral. For example, if you put your building up for collateral, the lender would foreclose on your building, taking possession of it in order to make their money back, much the same as a bank would do if you defaulted on your mortgage or car loan.

 

Hard money loans are a lucrative way to get the financing you need for your small business, especially if you have a large project you want to invest in and need the money fast. Make sure that you shop around with different lenders to see the financing options that are available to you. You might find a drastic difference in the interest rates and costs that different lenders offer you as each lender has a different threshold on the level of risk they can take at any given time. If you find that one lender turns you down, shop with another until you find the lender that will fit your business needs.

William Mahnic
William Mahnic is a Finance Professor at Case Western University and has spent more than 20 years in the finance industry before becoming a professor. Mahnic has appeared as a commentator on both TV and radio talk shows including NPR, Crain's Cleveland Business, WKYC 3 and The Washington Post. He has been interviewed in BusinessWeek, Wall Street Journal and The Los Angeles Times.

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