Hard money commercial loans could be a viable option for some investors looking for a way to buy real estate outside the traditional methods. For those considering these loans, it is critical to learn their requirements and implications.
What Is a Commercial Hard Money Loan and How Does It Work?
Commercial hard money lenders have different rules and requirements for borrowers to follow. They also set their own conditions. However, there are a few key components of the loans.
Typically, these loans are secured by the property itself, and that is for real property, such as a commercial building. These loans are often considered a last resort type of loan or one obtained for a short term because they typically have significantly higher interest rates.
The value of the loan is nearly always based on the value of the property that will work as collateral for it. Of lesser importance, and sometimes not considered at all, is the borrower’s creditworthiness.
Commercial hard money lenders are not traditional banks. Rather they are often private individuals or groups of private individuals. There is a significant amount of risk to the lender, and that is why costs tend to be higher with these loans.
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What Are Typical Terms for Commercial Hard Money Loans?
Each lender sets their requirements for the loans. Often hard money commercial real estate loans will have different terms and conditions. Some examples may include the following:
- Loan approval is often dependent on the value of the commercial real estate. In comparison, the basis for loan approval in traditional banks is generally the income, tax returns, other financials, and credit score of a borrower.
- Fees range widely, though they tend to be lower with commercial hard money loans than traditional loans. For example, most borrowers will need to pay for inspections and appraisals not required by private lenders.
- There are generally no credit score requirements for private lenders.
- Most often, these loans also carry less formal documentation and rules for obtaining them, as the private lender establishes the guidelines for them.
- Costs tend to be more significant, with higher interest rates, yet there may be some competitiveness with some commercial real estate loans.
- Funding is often much faster with hard money loans, often enabling the loans to close within 10 to 14 days, compared to up to three months with bank loans.
Commercial Hard Money Loan Requirements
Hard money commercial loans may not carry significant requirements. That is due to the private lender. In most cases, there will be some need to determine the value of the property since this is the core factor in determining the value of the loan. Some lenders may only provide loans for specific purposes or to those with significant experience in managing these types of investment properties.
Pros and Cons of Using Commercial Hard Money Loans
There are good and bad components of using commercial hard money lenders instead of traditional banks for funding.
What Are the Benefits?
Some of the benefits of these loans include:
- Faster approval process: For those who are engaging in house flipping or buying real estate that could sell quickly, the fast approval and funding of these loans can help to secure that property sooner. Commercial hard money lenders tend to be able to make decisions faster.
- Lower initial costs: Most private lenders do not require costly inspections or a significant application fee, which makes it easier for the borrower to obtain the loan. There will still be the need to verify income and financial documents.
- Some private money lenders are less worried about receiving repayment of the loan. That is because they may be able to sell the property if the borrower walks away from it at a higher premium.
Are There Any Risks?
Hard money loans do carry some risks to consider:
- Lower loan to value ratio: Most of the time, private money lenders will require borrowers to have a lower loan to value ratio. That means that there is a higher down payment required of the borrower to obtain the loan.
- Costs: The interest rates on these loans tend to be much higher than what you may pay on a traditional commercial loan. The rates may be as high as some subprime loans.
- Approval: Though it may be easier to obtain approval in some cases, finding a private lender who will work with your specific needs may be harder to do than some realize.
Can You Refinance a Hard Money Loan?
In theory, you can refinance a hard money loan. For example, it is common for a home flipper or a commercial building flipper to obtain a hard money loan for a property that needs significant work. They will make the repairs, and then, if they want to maintain it as a rental property, they can refinance the initial hard money loan into one with a better loan term or interest rate. This would allow the investor to take advantage of the newer, higher property value to obtain that loan.
There could be some restrictions on these loans, which is why carefully understanding the contract is critical here.
Commercial Hard Money Loans vs Bridge Loans
Commercial hard money loans may be used as bridge loans. That is a loan that is meant to be in place for just a short amount of time. This type of loan may be applicable for a period while repairs are being done, for example.
However, there are also bridge loans that are designed for this purpose from traditional banks and commercial lenders. These loans will still need to meet compliance and regulatory requirements set by the lender. In short, if a borrower plans to need funds for a short period of time, they may want to consider both bridge loans from a bank or credit union and hard money lenders.
Who Should Use Commercial Hard Money Loans?
There are some situations where hard money commercial loans could be considered a good option for borrowers. This includes:
- Flipping homes: In situations where investors plan to purchase property at a low price, fix it, and then sell it, the short-term nature of the loan may be ideal for a hard money investment.
- Investment properties: It may also be beneficial for those investors who plan to purchase and maintain investment property but may not qualify for a traditional loan due to credit limitations or other factors.
- Commercial property: Those who may not qualify to purchase commercial loans for larger projects and developments may wish to seek out private lenders who may be more willing to offer these loans.
The Best Alternative to Hard Money Loan
There are alternatives to hard money commercial real estate loans. Investors are likely to need to consider several financing options to determine which is best suited for their needs. Other options may include the following:
- Peer-to-peer loans
- Home equity lines of credit
- Land loans
- Cash-out refinancing loans
- Investment property loans
Wrapping Things Up
Hard money loans are one of the options for many investors who are unable to obtain a loan through other means. Though they can be more expensive, if they are short-term in nature, they may be worth the added cost.