A commercial hard money loan is a non-conventional commercial real estate loan that is not made by a traditional bank. This type of commercial financing has been in use for over 50 years. Such loans usually have a first lien on commercial property. If a loan has a secondary lien, it is known as mezzanine financing.
Three Business Mortgage Loan Choices
There are three financing options for most commercial real estate scenarios: traditional banks, intermediate lenders and hard money lenders. The primary rationale for a small business considering a commercial hard money loan is that traditional or intermediate commercial financing options are not viable.
In those situations where traditional banks and intermediate lenders both say “No,” it then makes good business sense to explore under what terms an alternative commercial loan might be available. Many viable small business projects can be funded only via a hard money lender. Before accepting “No” from the traditional banks and intermediate lenders as the “Final Answer,” a prudent small business borrower should determine if another lender will say “Yes.”
Commercial hard money loans are typically completed more quickly than a traditional commercial loan. Compared to traditional bank business loans, this alternative financing will generally involve a higher interest rate (prevailing range of prime rate plus 4-8 percent for typical scenarios), higher fees and shorter-term financing (one to three years). However, because many of these loans offer interest only terms, the payments can be lower than a fully-amortized loan with a lower interest rate.
Funding Scenarios
Three common commercial financing scenarios using alternative loans are described below.
Scenario # 1: Low Credit Scores
Most traditional commercial loans have very strict standards for acceptable credit scores by the guarantors for a commercial real estate loan. Alternative loans are more flexible and low credit scores are often acceptable.
Scenario # 2: Need to Obtain Commercial Financing Quickly
Traditional business financing will normally require several months to complete. A hard money loan can be obtained within a few days in some situations. This difference will be critical if commercial financing is required within a short time frame.
Scenario # 3: Special Small Business Situations Not Easily Understood by Traditional Banks and Intermediate Lenders
- Foreclosure
- Bankruptcy
- Special Purpose Properties
- Tax Liens
- Business Losses
- Negative Net Worth
- Less than one year in business
- Environmental Requirements
For each of the three scenarios described above, an alternative source for a commercial loan will involve shorter-term financing, higher fees and higher interest rates than a commercial mortgage from a traditional bank or an intermediate lender. However, the critical point which must not be overlooked is that for most situations covered by the three scenarios, commercial financing would be declined by either traditional banks or intermediate lenders. It is under these circumstances that a hard money loan becomes a practical and viable solution for many small business owners.
What If the Bank Says No?
The primary rationale for business borrowers to consider other sources for funding is the lack of alternative funding strategies. In most cases hard money loans can be viewed as “Plan B.” However, if “Plan A” is to obtain a conventional bank mortgage and the bank says “No,” then “Plan B” must be reviewed and considered by commercial borrowers.