How Hard Money Loans Work
The current credit crunch has resulted in many looking to alternative financing channels such as private money. One area that more and more people are looking to is the area of hard money loans.
The first and rather obvious question is what is a hard money loan? It is a loan that is based on an asset held by the person or business seeking the financing. The asset in question acts as the security for the loan should it not be repaid.
Flexibility is the key to finance. Owning something that has value, but cannot be used financially is the ultimate frustration. An asset such as a building or machinery is valuable, but does not pay the bills.
Hard money loans often sound like asset based loans. They are similar except hard money loans are easier to get because the lender is willing to overlook your poor finances and focus only on the value of the asset.
A traditional lender will not lend money to a business or person that has a valuable asset, but poor revenues or overall finances. The problem is the bank cannot justify the risk to regulators, particularly in this market.
While the private party is willing to take on the additional risk of a borrower having problems, the buyer is going to have to pay a premium to make the loan happen. That premium can be a serious disadvantage.
With hard money loans, profit comes in the form of points. A point is equal to one percent of the loan. It is not unheard of to pay 10 points or more up front on your hard money loan.
Given these high costs, you probably are wondering why anyone would go with one of these loans. In many cases, it is a matter of perspective. Essentially, many businesses or people use these loans to buy time.
For example, I am a manufacturer and own my building free and clear. Business is bad, but I have a 10 million dollar Navy contract coming in three months. No bank will help me because my current books are bad.
With millions in revenue just a short time away, the cost of a hard money loan really looks like a minor problem. The business is not buying a good load, it is buying time until that revenue starts coming in.
Obviously, these loans have their place in the finance market. With things being tight in the traditional finance markets, however, hard money loans are becoming more popular every month.
Filed under: Business