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How Do Commercial Hard Money Loans Really Work?

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As a commercial real estate investor, regardless of if you are new to the game, or a seasoned veteran, you have many options when it comes to securing a commercial real estate loan. While traditional lenders have been considered the “go-to” for commercial loans, as the guidelines tighten, the qualification processes have made it more and more difficult to acquire the needed loans.

One area, which has been pretty successful, and that is growing in popularity, provides an alternative to the traditional loans available to commercial investors – the commercial hard money loan.

However, if you aren’t sure about what these are, or how they work, it is best to gather a bit of information first. This will help ensure you find the lending option that is right for your particular needs.

Commercial Hard Money Loans Explained 

For any type of loan, it is the lender who will be taking on all the risk. The way that hard money loans are different than conventional bank loans is mainly how they are able to mitigate the risk. However, it is also in regard to the increased risk that hard money lenders are taking on by offering more unconventional deals. After all, if you were going to lend out $2 million, then you would want to make sure that there were additional ways to help protect yourself from going into default, too.

Understanding a Traditional Loan

When you seek traditional lending, from a private banking institution, it is going to focus on the ability the borrower has to make payments over time. This is why they rely on issues such as your payroll earnings, credit and more – all this helps to determine if the borrower is going to be able to cover the payments over a certain period of time.

More About the Hard Money Commercial Loan

With this type of lending, the loan is based on assets. What this means is that the amount of the loan will be based on the property that is put up as collateral. This type of loan is going to focus on the collateral’s value, instead of the cash flow or credit they have. Since the collateral is put up, it will protect the lender if default occurs, while encouraging the borrower to make payments in a timely manner. While the qualification process for a hard money loan is somewhat different, some prefer this method, over traditional bank loans.

How a Private Money Commercial Loan Works 

Now you have a general idea of how the hard money loans work differently than a traditional commercial loan. Here you can see one in action.

The first step in acquiring a hard money loan is to find the right lender. Not all hard money lenders are created equal and not all of them offer a commercial loan program. Also, not all the lenders are going to be able to offer the amount that you need. You need to find a lender you are comfortable with.

The next step is for you to identify the collateral that you want to use for the loan. Keep in mind, a hard money loan is based on the value of your collateral. The majority of collateral will include some type of retail property, apartment buildings, office buildings, industrial property or some type of non-owner occupied one to four family property that is held under a corporate name or by an LLC. While the exact documentation the hard money lender is going to require will vary, it will have to be enough to convince the lender of the perceived value of the collateral that is being used.

In addition to the documentation that is needed, a lender is also likely going to require an appraisal or a BPO to determine the collateral’s value. Then the lender will base the loan on the LTV (loan-to-value) ratio. If everything is able to check out, then the hard money lender will provide financing for the loan.

Important Things to Consider when Taking Out a Hard Money Loan

Now that you are aware of how a hard money loan works, it is important to consider a few things before taking this out. These considerations include:

  • Having good credit isn’t the most important factor
  • Getting a hard money loan is a faster process
  • The terms and interest of this type of loan are different

Are Hard Money Loans Really the Right Option? 

A hard money loan can help those who want to invest in commercial real estate in a landscape where banks won’t provide the desired loan. However, this doesn’t mean that a hard money loan is the right option for every situation.

It is best to evaluate your needs carefully to determine if this type of loan is right for you. Taking the time to consider all the options and then figuring out if the hard money loan is right for you is best. In the long run, this will ensure you get the loan you want and need without having to pay too much for the financing, which is always a benefit.