How Do Hard Money Loans Work for Commercial Investing?
If you’re interested in a commercial investment, but you don’t have funds on hand, or banks won’t give you the time of day, a hard money loan, also known as a bridge loan, may be able to help.
What is a Bridge Loan?
The goal of a hard money “bridge loan” is to act as the bridge from a temporary situation to a more permanent and conventional one. Hard money loans typically have higher interest rates and up-front costs, but they give you the infusion of cash you need to purchase a commercial property.
While banks and traditional lenders shy away from fix-and-flip-style properties, or hefty commercial real estate investments, you can provide demonstrable proof that you’ve got the financial backing you need – and that will make any bank’s eyes light up faster than you can say “Sold!”
So What’s the Difference Between Commercial Hard Money Lenders and Conventional Lenders?
There are several key differences you should be aware of when it comes to getting a commercial hard money loan over a traditional loan, namely:
Conventional Loan Interest Rates Versus Hard Money Loans
Conventional loans have lower interest rates than a hard money loan. There’s no hiding that fact. Because hard money loans are private loans made from investors, the interest rates associated with them can be up to three times higher than a conventional loan.
But keep in mind that even though the interest rate and associated costs are higher, they can get you the financial backing you need to purchase commercial real estate when banks won’t – owing to your credit, the type of property you want to buy, or other factors often outside of your control.
This is what it means to think of a hard money loan as a bridge loan – it’s giving you the financial backing you need in order to demonstrate to the banks that you have cash-in-hand and are ready to purchase commercial property.
Upfront Costs Associated with Hard Money Loans
Conventional loans usually have an up-front cost that’s as low as 1% of the total loan amount. With hardmoney loans, the up-front costs tend to be higher – around 2-5%. Remember, private lenders aren’t in the business of being banks, and they can’t afford to lose money. This higher up-front cost gets you the commercial funding you need, but also helps to separate the wheat from the chaff when it comes to loaning to just anyone.
Loan Terms for Hard Money Loans are Shorter than Conventional Loans
Hard money loans are typically held for much shorter timeframes than their conventional counterparts. A traditional loan can last for as little as five years, all the way up to 30 years. Hard money loans, on the other hand, usually have terms that average around 6-12 months.
The reason for this is because they are designed to provide a short-term solution that helps to guide you toward a longer-term, and thereby more affordable option.
Credit Matters – But Not As Much as You Might Think
To banks, credit is an indispensable way of determining your “loan-ability”. Poor credit or a low credit score can instantly crush any opportunity you may have to invest in commercial real estate. But with hard money loans, your credit doesn’t have quite the impact on your approval as you may think.
With hard money loans, your credit may have flaws, but since the loan is based on the equity of the property rather than your personal credit score, you can still qualify for a hard money loan even if you have a few bumps in your credit score.
Hard Money Loans Close Much Faster than Conventional Loans
Conventional loans require more time to close deals because of all the paperwork involved: the deal needs to be underwritten, inspections need to be conducted, legal departments need to be sure that everything is on the up and up, and the loan committee has to approve everything before the process is complete.
This can take as much as 30-60 days from start to finish. In a competitive commercial real estate market, that’s’ time you can’t afford to waste.
Hard money loans close much, much faster – often as little as 7 days or less, because individuals look at the specifications of the deal itself, rather than slogging through tons of paperwork. The individuals that lend money from hard money loans are typically wealthy investors themselves, looking to grow their own money, so they tend to shy away from reams of paperwork in favor of offering a short-term solution to other promising, aspiring lenders.
Now, it’s understandable that you may have many questions about hard money loans. Let’s take a look at the most common ones:
Does My Credit Matter for a Hard Money Loan?
It does – but it’s not as much of a “deal-breaker” as in conventional lending. A hard money lender will go through the process of qualifying the deal, but in doing so, they don’t look at credit as a “make or break” option. Instead, they look at three things, in this order:
- The property
- The area
- You
Now, although you’re third on the list, you may have some explaining to do if there are major blemishes on your credit report like foreclosures or bankruptcies, so be prepared for that.
Is There 100% Financing for Hard Money Loans? How Much Money Do I Need to Put Down?
Hard money loans do not have 100% financing options. You’ll need to put down between 20-40% depending on the deal itself. This includes the down payment plus the closing cost, which can be 5-6% of the loan.
The good news is that hard money lenders are often more open to creative financing situations than their conventional counterparts. For example, if a hard money lenders requires a 30% down payment, it may seem difficult to come up with the cash needed to meet that requirement.
But there again, you’re thinking in terms of conventional loans. Things that banks shy away from are often wholeheartedly accepted by hard money lenders. Someone could pay 10% down and carry the other 20% for three years as a second mortgage. This kind of deal wouldn’t be approved by a bank, but a hard money lender may be open to the possibility because their 30% down payment requirement is satisfied.
How Can I Help Assure that My Loan Gets Approved? Any Secrets or Advice?
You, your lender, the person you’re borrowing money from, and your property manager all need to be in agreement on the deal and on your investing exit strategy. Having everyone in agreement ensures that you are in the best possible position to get your loan approved and get the deal closed.
If you’re interested in exploring the options that a hard money loan can provide, or you’re looking at getting a hard money loan for your commercial real estate venture, give us a call at (818) 584-2424 and one of our hard money lending specialists will work with you to help answer any questions you may have and help you take the next step toward commercial property investing with hard money loans.